Introductory Economics

Introduction

Income Effect:
Income Consumption Curve:

• With given money income to spend on goods, given prices of goods, and indifference map (which portrays the tastes and preferences of the consumer), the consumer will be in equilibrium on the IC map.
• Now we are interested to know the effect of change of consumer’s income on his purchases when the prices of the goods remain unchanged.

Income effect means the change in consumers; purchases of the goods as results of change in his money income (Fig).

• With given prices and income consumer is in equilibrium at Q1 (tangency point of price line and IC). Now with the increased income and prices of the commodities being the same consumer is in equilibrium at Q2. Similarly Q3 and so on, it can be noted that an increase in the income of the consumer, he goes to higher IC to have higher level of satisfaction with more of the two goods .Such goods are known as Normal Goods.
• Curve joining the points Q1, Q2 and Q3 is called as Income Consumption Curve. The change in consumer’s purchases of the goods as a result of a change in his money income is called income effect.
• Income effect can be either positive or negative. Income effect for a good is positive when with the increase in the income; the consumption of the good also increases. Such goods are known as Normal Goods. When the income effect of both the goods represented on both the axes of the figure is positive, the income consumption curve (ICC) will slope upward to the right as shown in figure above.
• When increase in the income of the consumer, results in the decreased consumption of the good, then the good is known as inferior good. In case of inferior goods, indifference map would be such as to yield income consumption cure which either slopes backward (i.e. upward to left) or downward to the right as shown in the figures below.

• In figure 1, ICC slopes backward (upward to the left) i.e. bends towards Y- axis. This shows good X to be an inferior good. Similarly, in figure 2, ICC slopes downward to the right i.e. bends towards X-axis. This shows good Y to be an inferior good.

Engel’s Law:
The income-consumption curve can be used to derive the relationship between the level of income and the optimum quantity purchased of each good. German economist Ernest Engel was the first to show this relationship therefore this curve is named after him as Engel curve.

• An Engel’s cure is a curve which shows optimum quantity of a commodity purchased at different levels of income. Engel’s curve indicates how much quantity of a commodity a consumer will consume at different levels of his income in order to be in equilibrium. These curves are important for applied studies of economic welfare and for the study of family expenditure patterns.
• It explains how consumer spending varies among income groups. It can be drawn with the help of income-consumption curve. In figure A below, good X and good Y are shown on X-axis and Y-axis, whereas in figure B income on Y-axis and good X on X-axis.
• Suppose the price of good X is Re. 1 and of good Y Re. 0.50.When the income of the consumer is Rs 4, he buys 3 units of good X and 2units of good Y as shown on point E on ICC in figure A. Say his income increases to Rs 6, he can now buys 4units of good X and 4 units of goody, as shown at point E1 on ICC. Similarly if his income increases to Rs. 8, he buys 5 units of good X and 6 units of good Y.
• Corresponding to these three levels of income, three perpendiculars have been drawn on X-axis of figure B Point A shows that at an income of Rs 4 the consumer purchases 3 units of commodity X. At income level of Rs 6, he buys 4units of good X as shown at point B on figure B. Similarly at income level of Rs 8, he buys 5 units of good X. By joining points, A, B and C the curve EE known as Engel’s curve which shows equilibrium quantities of good X purchased at different levels of money income.