Income effect

In the consumer equilibrium analysis we assumed that the income of the consumer remains constant,  given the prices of Goods X and Y.  Given the tastes and preferences of the consumer and the prices of the two goods,  if the income of the consumer changes,  the effect it will have on his purchases is known as the INCOME EFFECT.

If the income of the consumer INCREASES his budget line will shift UPWARD to the RIGHT, parallel to the original budget line. On the contrary, a FALL in this income will shift the budget line INWARD to the left. The budget lines are parallel to each other because relative prices remain UNCHANGED.

BUT an INCOME-CONSUMPTION CURVE can have any shape provided it does not intersect an IC more than once. We can have 5 types of income-consumption curve.

1) The first type is explained in the figure below where the ICC curve has a positive slope throughout it's range. Here the income effect is also positive and both X and Y are normal goods.

***draw diagram
Normally,  when the income of the consumer increases, he purchases larger quantities of 2 goods. In the above figure, he buys RA of Y and OA of X at the equilibrium point R on the budget line PQ. As his income increases, he buys SB of Y and OB of X at the equilibrium point S on P1Q1, budget line and still more of 2 goods TC of Y and OC of X,  on the budget line P2Q2. Usually, the ICC curve slopes UPWARD to the RIGHT.

2) The second type of ICC curve may have a positive slope in the beginning but become and stay horizontal beyond a certain point when the income of the consumer continues to increase.
****draw the diagram
In the above figure,  the income-consumption curve slopes upwards with the increase in income upto the equilibrium point R at the budget line P1Q1 on the IC curve I2. Beyond this point it becomes HORIZONTAL which signifies that the consumer has reached the saturation point with regard to the consumption of good-Y. He buys the same amount of Y(RA)  as before despite further increases in his income.  It often happens in the case of a Necessity (like salt)  whose demand remains the same even when the income of the consumer continues to increase further.  Here Y is a necessity.

3) The third type of ICC curve is vertical.
****draw the diagram
The above figure shows a vertical ICC when the consumption of Good-X reaches the saturation level R on the part of the consumer.  He has no inclination to increase it's purchases despite further increases in his income. He continues to purchase OA of it even at higher income levels . Thus X is a necessity here.

4) This type of ICC relates to Inferior Goods. The demand Of inferior goods falls,  when the income of the consumer increases beyond a certain level and He replaces them by superior substitutes. He may replace coarse grain by wheat
Or rice , and coarse cloth by a fine variety.

****draw diagram
In the above figure, Good-Y is the inferior good and Good-X is the superior or luxury good.
Up-to point R, the ICC curve has a positive slope and beyond that it is negatively inclined.
The consumer's purchases of Good-Y falls with the increase in his income.

5) This type of ICC also relates to Inferior Goods. The demand of inferior goods falls, whenthe income of the consumer increases beyond a certain level and He replaces them by superior substitutes. He may replace coarse grain by wheat
Or rice , and coarse cloth by a fine variety.

***draw diagram
In the above figure, Good-X is shown as Inferior And Good-Y is a superior good beyond the
Equilibrium point R when the ICC curve turns back upon itself. In both these cases the
Income effect is negative.




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