Income Effect

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DEFINITION of 'Income Effect'

In the context of economic theory, the income effect is the change in an individual's or economy's income and how that change will impact the quantity demanded of a good or service. The relationship between income and the quantity demanded is a positive one, as income increases, so does the quantity of goods and services demanded.

BREAKING DOWN 'Income Effect'

For example, when an individual's income increases, other things remaining the same, that person will demand more goods and services; thus increasing their consumption. The degree to which a person or economy will spend more of their income on consumption is called the marginal propensity to consume (MPC). The MPC depends on the individual's or economy's saving characteristics.

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RELATED FAQS
  1. How do you calculate the income effect distinctly from the price effect?

    Economists calculate the income effect separately from the price effect by keeping real income constant in the calculation. ... Read Full Answer >>
  2. What's the difference between the income effect and the price effect?

    The price effect is the impact on the market based on how the consumer is spending money as a result of the income effect. ... Read Full Answer >>
  3. Is there a way to invest in the income effect?

    Investing in the income effect consists of investing in areas that are affected when an individual's income increases. The ... Read Full Answer >>
  4. What effect does the income effect have on my business?

    The income effect may have positive or negative consequences on a small business, depending on many factors. The income effect ... Read Full Answer >>
  5. What's the difference between the substitution effect and price effect?

    The substitution effect is caused solely by the change in price of a consumer item. The price effect relates directly to ... Read Full Answer >>
  6. What's the difference between the substitution effect and the income effect?

    The substitution effect refers to consumers spending money on items of lower value, while the income effect refers to how ... Read Full Answer >>
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    The short answer to this question is "both". Finance, as a field of study and an area of business, definitely has strong ... Read Full Answer >>
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