Income Effect

Examples of Income Effect in the following topics:

• Impact of Income on Consumer Choices

  • The wealth effect differs slightly from the income effect.
  • The wealth effect reflects changes in consumer choice based on perceived wealth, not actual income.
  • Income effects on consumer choice grow more complex as the type of good changes, as different product and services demonstrate different properties relative to both other products/services and a consumers preferences and utility.
  • Income increases will thus affect the consumption of these goods interchangeably, resulting in increase in the quantity of either or both.
  • Break down changes in consumption into the income effect and the wealth effect

• Applications of Principles on Consumer Choices

  • The income effect and substitution effect combine to create a labor supply curve to represent the consumer trade-off of leisure and work.
  • Central principles to analyzing consumer actions and choices are income effect and the substitution effect, which ultimately generate a labor supply to illustrate the labor-leisure trade-off for consumers.
  • The substitution effect is closely related to that of the income effect, where the price of goods and a consumers income will play a role in the decision-making process.
  • Income Changes: When income changes rises or falls, consumption of certain types of goods will have a positive or negative correlation with these changes.
  • Explain the labor-leisure tradeoff in terms of income and substitution effects

• Income Elasticity of Demand

  • Zero income elasticity of demand (YED=0): A change in income has no effect on the quantity bought.
  • Income elasticity of demand measures the percentage change in quantity demanded as income changes.

• The Importance of Aggregate Decisions about Consumption versus Saving and Investment

  • In order to understand the effects of aggregate decisions of consumption, savings, and investment, we must look at aggregate demand (AD).
  • The aggregate demand curve is downward sloping but in variation with microeconomics, this is as a result of three distinct effects: the wealth effect, the interest rate effect and the exchange-rate effect.
  • The wealth effect is specifically related to the value of assets; market participants will adjust consumption in-line with their perception of the appreciation or depreciation of held assets (a home; equity investments, etc.).
  • The interest rate effect has to do with access to inexpensive funding, which provides an incentive to increase current period expenditures; while the exchange-rate effect has to do with expenditure decisions related to imports or foreign related expenditures, as the exchange rate is perceived to be favorable to the domestic currency, expenditures on foreign items or imports will increase.
  • Spending = Income – Net Savings = Income + Net Increase in Debt

• How Income is Allocated

  • However, economists view the impact of technological progress to outweigh the effect of globalization, as technology has effectively been substituted for more expensive wage labor.

• Subsidies and Income Supports

  • While these subsidies above are designed to have a positive effect on consumers looking to purchase foods, there are externalities to this process that can have a damaging affect on other groups:
  • Global Effects: While domestic subsidies are good for driving up production domestically, it suppresses competition in the context of international trade.
  • Developing Nations: A complement to the above discussion is the effect on poverty and developing nations without the infrastructure to provide subsidies for their own farmers.
  • Nutrition: Another interesting side effect of subsidies and the artificially reduced price of food is obesity and overeating.
  • Politics must find a way to mitigate the negative consequences while increasing the positive effects, allowing for balanced and healthy consumption across all demographics.

• Current Topics in Income Distribution

  • Income inequality in the United States has grown significantly since the early 1970s.
  • Income inequality in the United States has grown significantly since the early 1970s and has been the subject of study of many scholars and institutions.

• Disposable Income

  • Income left after paying taxes is referred to as disposable income.

• Personal Income

  • Income from production is generated both by the labor of individuals (for example, in the form of wages and salaries and of proprietors' income) and by the capital that they own (in the form of rental income of persons).
  • Income that is not earned from production in the current period—such as capital gains, which relate to changes in the price of assets over time—is excluded.

• Introducing Aggregate Demand

  • It is often called the effective demand or aggregate expenditure (AE), and is the demand of all gross domestic product (GDP).
  • From a quantitative perspective this is simply expressed as: Spending = Income + Net Increase in Debt.