income effect

The income effect in economics describes how a change in the price of a good or service impacts a consumer's purchasing power, and consequently, their demand for that good or service. When the price of a good increases, a consumer's overall purchasing power decreases. This reduction in purchasing power, independent of the relative price change, is known as the income effect.1

Conversely, if the price of a good decreases, a consumer's purchasing power increases, potentially leading them to buy more of that good or other goods. This effect is distinct from the substitution effect, which refers to consumers switching to cheaper alternatives when prices change. The income effect can also be influenced by changes in income itself. For instance, an increase in income might lead consumers to buy less of an "inferior good" and more of a preferred, more expensive commodity.12