Real-World Examples of the Income Effect on Consumer Choices

📚 Quick Study Guide

🔍 The income effect describes how changes in a consumer's purchasing power due to a change in income affect their consumption of goods and services.

🍎 For a normal good, an increase in income leads to an increase in consumption, and a decrease in income leads to a decrease in consumption.

🍜 For an inferior good, an increase in income leads to a decrease in consumption, and a decrease in income leads to an increase in consumption.

➕ The income effect is calculated by understanding how much of a change in quantity demanded is derived from the change in real income. There are two types of income effects:

📊 Positive income effect: Happens with normal goods. Consumer buys more when his income increases.

📉 Negative income effect: Happens with inferior goods. Consumer buys less when his income increases and switches to better alternatives.

Practice Quiz

1. Question 1: Sarah gets a raise at work. As a result, she buys fewer instant noodles and more fresh produce. This is an example of:
   1. A) The substitution effect.
   2. B) An inferior good and a normal good.
   3. C) A normal good and the law of demand.
   4. D) An inferior good and the law of supply.
2. Question 2: John's income decreases. He starts buying more generic brand cereal instead of the name-brand cereal he usually buys. Generic brand cereal is, for John:
   1. A) A normal good.
   2. B) A luxury good.
   3. C) An inferior good.
   4. D) A complementary good.
3. Question 3: Which of the following is the most likely example of an inferior good?
   1. A) Organic vegetables.
   2. B) Public transportation.
   3. C) Designer clothing.
   4. D) Premium coffee.
4. Question 4: Maria receives a bonus at work and decides to treat herself to a fancy dinner at an expensive restaurant. This demonstrates the income effect on a:
   1. A) Normal good.
   2. B) Inferior good.
   3. C) Giffen good.
   4. D) Veblen good.
5. Question 5: When a person's real income falls, what typically happens to their consumption of normal goods?
   1. A) It increases.
   2. B) It decreases.
   3. C) It stays the same.
   4. D) It fluctuates randomly.
6. Question 6: Suppose a consumer's income increases. Which of the following goods would they likely buy LESS of, assuming the income effect is in play?
   1. A) Steak.
   2. B) Bottled water.
   3. C) Ramen noodles.
   4. D) Movie tickets.
7. Question 7: Which statement best describes the relationship between income and consumption of an inferior good?
   1. A) As income increases, consumption increases.
   2. B) As income increases, consumption decreases.
   3. C) Income has no effect on consumption.
   4. D) Consumption remains constant regardless of income.