Income Effect On Indifference Curve

Movement of the consumer from q on indifference curve ic to s on higher indifference curve ic 2 along the income consumption curve is the result of income effect of the price change.

Income effect on indifference curve. The sum of the two effects to be very small. In some cases if a good is inferior enough the positive income effect may be so large that it leads to price increases decreases being accompanied by overall quantity increases decreases. This is shown below for the situation where u x y x 0 5 y 0 5 p. However income has fallen causing the consumer to choose from a lower indifference curve i2.

Normally when the income of the consumer increases he purchases larger quantities of two goods. Each point on an orange curve known as an indifference curve gives consumers the same level of utility. The inferior good s large income effect moves in the opposite direction of the substitution effect causing the overall change i e. A change in income is represented in an indifference curve diagram as a parallel shift of the budget line.

But the consumer will not be finally in equilibrium at s. The change due to income is therefore b to c q2 to q1 in this case of a normal good the income and substitution effect reinforce each other both leading to lower demand. It means that the increase in real income or purchasing power of the consumer as a result of the fall in price of x is equal to pa in terms of y or l x b in terms of x. An income effect represents change in consumer s optimal consumption combination on account of change in her his income and thereby changes in her his quantity purchased prices of goods x p x and y p y remaining unchanged.

The consumer is better off when optimal consumption combination is located on a higher indifference curve and vice versa.