Income Effect

The income effect is the change in consumption that results from a change in income. It is one of the two effects that explain the relationship between income and consumption. The other effect is the substitution effect.

The income effect is positive when consumption increases with income. This is because as income increases, people can afford to buy more goods and services. The income effect is negative when consumption decreases with income. This is because as income decreases, people have to cut back on their spending.

The income effect is important because it helps to explain how people's spending changes over time. For example, when people's incomes increase, they tend to spend more on luxury goods and services. This is because luxury goods and services are more expensive than necessities, so people can only afford to buy them when their incomes are high.

The income effect is also important because it can help to explain why people's savings rates change over time. When people's incomes increase, they tend to save more money. This is because they have more money to put away for the future. However, when people's incomes decrease, they tend to save less money. This is because they have less money to spare.

The income effect is a complex concept, but it is an important part of understanding how people's spending decisions are made.