Income effect and consumption relationship advice

Determining the Relationship Between Consumption and Household Income

income effect and consumption relationship advice

Summary. A major utility company wished to understand the relationship between consumption of their product and their clients' household income in order to. Theory tells us, in particular, that in looking for an income effect we must hold .. be a stronger temporal relationship between income and current consumption. Consumer spending is the private consumption of goods and services. Learn what The most important determinant is disposable income.

Similarly, when income increases then entire budget constraint shifts outwards and it is a parallel shift. This is shown by budget constraint P2L2 in Figure. When consumer's income decreases, the budget constraint moves inwards. This is shown by budget constraint P1L1 in Figure. The optimal consumption is located at point e1 at which the consumer buys OX1 units of good X and OY1 units of good Y. Similarly, when consumer's income increases, the budget constraint moves outwards.

This is shown by budget constraint P2L2. The optimal consumption is now located at point e2, at which the consumer buys OX2 units of good X and OY2 units of good Y.

Sum Up The curve obtained by joining optimal consumption combinations such as e1, e and e2 is called the income consumption curve ICC. The ICC in Figure. Here income effect is positive for goods X and Y. Negative Income Effect We now study negative income effect. Good X is an inferior good and good Y is a normal good. Negative Income Effect When income of the consumer increases, then entire budget constraint shifts outwards and it is a parallel shift.

INDIFFERENCE CURVES: INCOME EFFECT - WikiEducator

This is shown by budget constraint P1L1. The optimal consumption is now located at point e1, at which the consumer now buys OX1 units of good X and OY1 units of good Y.

The consumer is better-off in terms of total utility.

income effect and consumption relationship advice

As mentioned in chart. The consumer increases quantity demanded of good Y as good Y is a normal good. Here income effect is negative for good X. Zero Income Effect We now study zero income effect.

Income–consumption curve

Good X is a neutral good and good Y is a normal good. When the people are poor, they cannot afford to buy the superior goods which are often more expensive.

income effect and consumption relationship advice

Hence as they become richer and can afford to buy more expensive goods they switch to the consumption of superior and better quality goods. For instance, most of the people in India consider cheaper common food grains such as maize, jawar, bajra as inferior goods and therefore when their income rises, they shift to the consumption of superior varieties of foodgrains like wheat and rice. In case of inferior goods, indifference map would be such as to yield income consumption curve which either slopes backward i.

It would be noticed from these two figures that income effect becomes negative only after a point. It signifies that only at higher ranges of income, some goods become inferior goods and up to a point their consumption behaves like those of normal goods. This shows good X to be an inferior good, since beyond point Q2, income effect is negative for good X and as a result its quantity demanded falls as income increases. This signifies that good Y is an inferior good because beyond point Q2, income effect is negative for good Y and as a result its quantity demanded falls as income increases.

It follows from above that the income consumption curve can have various possible shapes. But normal goods can be either necessities or luxuries depending upon whether the quantities purchased of the goods by the consumers increase less than or more than proportionately to the increases in income.

income effect and consumption relationship advice

On the other hand, if the quantity purchased of a commodity increases more than proportionately to the increases in income, it is called a luxury. On the other hand, the slope of income consumption curve ICC3 is decreasing which implies that the quantity purchased of good X increases more than proportionately to increases in income and therefore in this case good X is luxury and good Vis necessity.

Income Effect: Income Consumption Curve (with curve diagram)

It will be seen from Fig. If income effect is positive for both the goods X and Y, the income consumption curve will slope upward to the right as in Fig.

But upward-sloping income consumption curves to the right for various goods may be of different slopes as shown in Fig. If income effect for good X is negative, income consumption curve will slope backward to the left as ICC in fig 8. It may however be pointed out that given an indifference map and a set of budget lines there will be one income consumption curve.

Income Effect: Income Consumption Curve (with curve diagram)

A noteworthy point is that it is not the indifference curves which explain why a good happens to be an inferior good. In other words, indifference curves do not explain why income effect for a good is negative. Indifference curves can only illustrate the inferior good phenomenon.