Income effect refers to the changes in equilibrium position when income changes but prices of goods remain constant. Since with every increase in income, the budget line shifts outwards, new equilibrium levels are established at successively higher indifference curves. The line joining the successive points of equilibrium is called the income consumption curve (ICC).
For normal goods ICC is upward rising curve showing that an increase in income leads to larger purchase of both the goods X and Y. but in case of inferior goods, ICC is backward bending curve. It bends towards Y- axis if goods measured on the X – axis is inferior. Similarly, it bends towards X – axis if the good measured on the Y – axis is inferior.
Thus, while in the case of normal goods, income effect is positive, i.e. larger amount of both goods is bought when consumer’s income increases; in case of inferior goods, income effect is negative, i.e. less of this inferior good is purchased when consumer’s income increases.
SUBMIT ASSIGNMENT NOW!