Like everyone else, you go to work every day, do your job, and collect your paycheck at the end of every month! However, one of the months you suddenly noticed that the salary paid to you is significantly higher than usual. You've been given a raise! Now, since your income has increased, aren't you capable of spending more on goods or services than usual? This is referred to as an Income Effect. In other words, how changes in income affect the consumer decisions of purchasing any goods or services and ultimately, affecting the Demand.
Change in Income Influences Consumer Demands
The income effect principle implies how a consumer spends money influenced by an increase or decrease in his income. An increase in income results in demand for more goods and services and thus spends more money. A decrease in income results in the exact opposite. Businesses are generally affected by the effect when incomes are lower, and consequently, less spending occurs. But this is not the case always.
The income effect can have both positive as well as negative effect on a business!
For instance: A small-scale business that specializes in the production of goods that are purchased when incomes have decreased, it might see a boom in profits. Examples of such businesses include discount stores and retailers who sell goods in bulk.
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| REF: https://www.youtube.com/watch?v=J6qBu0LreAI&t=377s |
An additional factor to consider is the Substitution Effect, which occurs when the price for a product changes and consumers have an incentive to consume more of the good with a relatively lower price and less of the good with a relatively higher price.
Here Price plays a crucial role!
The typical response to an increase in prices is that buyers choose to consume less of the products at higher prices.
So, how the change in Prices relate to Income?
For Example: Consider the price of milk goes down by Rs.20. Now, the decrease in the price of milk increases the amount of money left with you that is also known as free money. This means you can either buy more milk, or other products. While higher prices make buyers feel like they have less money on hand, and therefore, causes them to buy less. On the other hand, lower prices make buyers feel a little content and cause them to purchase more.
Another very important thing to consider is the vast inequality in the distribution of income that also has a power over Market Demand.
Effect of Income Inequality on Demand
Higher income inequality means that the incomes of the rich keep increasing and those of the poor keep decreasing, which affects the overall demand and consumption of a product.
However, it also depends on the product. If it is an essential commodity which is available without any constraints in supply then there may not be any change in demand. For Example, edible salt. It is an essential commodity and perhaps difficult to replace in our daily life. The demand for salt does not go up when the consumer income goes up. Also, a decreasing income does not cut consumption since the supply is enough at a very stable inflation-adjusted price. An effect on demand might happen only if there is a severe shortage of supply due to which prices go up significantly.
Therefore, Demand does significantly depend on Income. Higher income means the more purchasing power. Therefore, with the increase in income people can afford to buy more. This is why an increase in income has a positive effect on the demand for a good.
However, it also depends on the product. If it is an essential commodity which is available without any constraints in supply then there may not be any change in demand. For Example, edible salt. It is an essential commodity and perhaps difficult to replace in our daily life. The demand for salt does not go up when the consumer income goes up. Also, a decreasing income does not cut consumption since the supply is enough at a very stable inflation-adjusted price. An effect on demand might happen only if there is a severe shortage of supply due to which prices go up significantly.
