The Impact of Income Effect on Fruit Budget

What is income effect?

The income effect is an expression of how changes in relative market prices and incomes impact consumption patterns for consumer goods and services. Consumer choice theory, which links preferences to consumption expenditures and consumer demand curves. In other words, it is the shift in consumer spending power brought on by a change in real income that affects the demand for a commodity or service. This shift in revenue may be the consequence of higher pay, for example, or the release of previously held funds due to a drop in price or rise in the cost of an item that is being purchased.

The Impact of Income Effect on Fruit Budget

Imagine a scenario where Sam has a so-called fruit budget, which he uses to buy only pears and avocados. Now, let's assume that the price of pears decreases. How does this change in the price of pears affect Sam's fruit-buying habits?

The decrease in the price of pears increases Sam's real income, which enables Sam to buy more fruits in general. This is known as the income effect. When the price of a good decreases, consumers like Sam can afford to buy more of that good as well as other goods, leading to a change in their buying behavior.

As a result of the decrease in the price of pears, Sam will likely choose to buy more pears and fewer avocados. This is because pears have become relatively less expensive compared to avocados, making them a more attractive option for Sam within his fruit budget.

Therefore, the income effect in this scenario is evident through Sam's increased purchasing power and his decision to allocate his budget differently due to the change in price. Understanding the impact of income effect on consumer choices is essential in analyzing market dynamics and consumer behavior.