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What Is Income Effect?

Income effect is an economics term that is used to refer to the changes in the spending habits of consumers. These changes are usually the result of the fluctuations in the prices of consumer goods. Logic dictates that how and what people buy depends on their income and the prices of goods. For a certain income, one can only purchase so much. If prices of goods go down, one can purchase more. On the other hand, if the prices of goods go up, one has to purchase less.

The income effect is only one factor that may result in the changing of the spending habits of people. Naturally, when one’s income changes, the spending habits can also change. Even if the prices of goods and services stay the same, if an individual’s income suffers a negative change, then he might have to purchase less - either in quality or quantity. Alternatively, if an individual’s income goes up, then he also might want to change his spending habits by purchasing more.

Another situation wherein one can observe the income effect is when there is no change in income but the individual finds other ways to keep his purchasing power relatively the same. This can be done by opting to purchase lower quality goods are lower prices. By doing so, the individual may still be able to purchase goods in the same quantity that he used to, albeit having to settle for less in terms of quality. For example, instead of buying branded cleaning products, one may opt to buy supermarket or generic brands.

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