Income effect - total demand will increase from 3 to 4...

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Income effect There is another cause for increase in demand of a good of which price falls. It is in the form of an income effect. As a result of a fall in the price of a commodity, a consumer becomes ’richer’ and his income increases. Let us suppose that a consumer has a sum of $12 to spend on a certain good, the price of which is $4 per unit. With his income he can purchase 3 units of the good. When the price of the good falls from $4 to $3 and if he continues to buy 3 units as before then $9 would be enough. He is now left with $3 of ’additional’ allowance. This is the income effect . If he decides to spend these additional $3 on the same good his
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Unformatted text preview: total demand will increase from 3 to 4 units. The income effect further enables a consumer to increase his demand for cheaper goods. Note that a rise or fall that occurs with a change in the price of a good is not an increase in the money income of a consumer (which is constant as $12) but it is an increase in the real income of a consumer. Since an increase in income and an increase in consumption are changes in the same direction, the income effect is said to be direct and positive. The income effect is generally positive for ’normal’ goods. Only in the case of exceptional type of ’inferior’ goods the income effect becomes negative ....
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This note was uploaded on 11/26/2011 for the course ECONOMIC ec 201 taught by Professor - during the Fall '10 term at Montgomery.

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