The Income Effect in Economics: Definition & Example

Lesson Transcript
Instructor: Brianna Whiting

Brianna has a masters of education in educational leadership, a DBA business management, and a BS in animal science.

In this lesson, you'll learn about income effect, or how changes in wages and prices affect your purchasing decisions. You'll also explore some real-life examples of income effect and their impact on our everyday lives.

What Is Income Effect?

Like most of us, you go to work, do your job, and collect your paycheck. However, one Friday, you notice that your paycheck is significantly bigger than usual; you've been given a raise! Now that your income has increased, are you going to buy more goods or services? This is what we call income effect, or how changes in income affect the amount of goods or services consumers will demand or purchase.

According to the principle of income effect, if an individual gets a raise in income, he will also demand an increased amount of goods and services. However, if an individual's income decreases, then so will his demand for goods and services.

An error occurred trying to load this video.

Try refreshing the page, or contact customer support.

Coming up next: The Market Supply Curve: Definition, Principles & Equation

You're on a roll. Keep up the good work!

Take Quiz Watch Next Lesson
Your next lesson will play in 10 seconds
  • 0:00 What Is Income Effect?
  • 0:42 Income Effect and Price
  • 1:33 Real-Life Examples
  • 2:43 Lesson Summary
Save Save Save

Want to watch this again later?

Log in or sign up to add this lesson to a Custom Course.

Log in or Sign up

Speed Speed

Income Effect and Price

Income is not the only factor to consider when discussing income effect; price also plays a role. For example, as the price of goods and services increases, there will be a lower demand for the goods and services. When the price decreases, there will be a higher demand.

So, how are changes in prices related to income? Well, let's say the price of milk goes down $1.00. The decrease in the price of milk increases the amount of money left from your paycheck, also known as free money, so you can buy more milk, or something else. While higher prices don't actually affect your paycheck, they can make you feel like you have less money, and therefore, cause you to buy less. Consequently, lower prices make you feel a little richer and able to buy more than you did before.

To unlock this lesson you must be a Member.
Create your account

Register to view this lesson

Are you a student or a teacher?

Unlock Your Education

See for yourself why 30 million people use

Become a member and start learning now.
Become a Member  Back
What teachers are saying about
Try it now
Create an account to start this course today
Used by over 30 million students worldwide
Create an account