The income effect associated with a change in the price of good x:
A)describes the change in the level of consumption as a result of the consumer's change in utility, holding price constant.
B)describes the change in the level of consumption, holding utility constant.
C)describes the change in relative purchasing power.
D)can be either negative or positive.

Question

Quizplus · Accepted Answer

The income effect can be either negative or positive, depending on whether the good is a normal good or an inferior good. If the good is a normal good, an increase in price will lead to a decrease in quantity demanded due to the decrease in purchasing power of the consumer. This is a negative income effect. On the other hand, if the good is an inferior good, an increase in price may actually lead to an increase in quantity demanded due to the consumer's switch to a cheaper alternative. This is a positive income effect. Therefore, the income effect is not directly related to a change in utility or holding a variable constant. The income effect associated with a change in the price of good x can be either negative or positive, depending on whether the good is a normal good or an inferior good. If the good is a normal good, a decrease in its price will increase the consumer's real income, leading to an increase in the quantity consumed, while an increase in its price will have the opposite effect. For an inferior good, the opposite holds true. Therefore, the income effect describes the change in the level of consumption as a result of the consumer's change in purchasing power, holding the price constant.

The Income Effect Associated with a Change in the Price