Question

What is income effect? What determines it whether income of a person or price of commodity

Answer 1

Income effect is the shift in the budget line either to the right or left as a result of change in consumers income or price of either goods. income effect can be seen from the indifference curve analysis involving the budget line.when there is an increase in consumer's income,the budget line shifts rightward showing a split of income between the two commodities and vice versa,ceteris paribus. Also when there is a change in price of a commodity,there are two effects(IN THE PRICE EFFECT) which are the INCOME EFFECT AND the SUBSTITUTION EFFECT. Income effect is the increase or decrease in real income or purchasing power while the substitution effect is the inherent tendency of the consumer to substitute the good that the price has reduced for the good that it price remains the same. These two effects can be separated using two approaches namely THE HICKSIAN APPROACH AND THE SLUSTKY APPROACH