What Is the Income Effect? Its Meaning and Example

Consider a consumer who on an average day buys a cheap cheese sandwich to eat for lunch at work, but occasionally splurges on a luxurious hot dog. These goods are highly desired and can be purchased when a consumer’s income rises. In other words, the ability to purchase luxury goods is dependent on a consumer’s wealth or assets. Luxury items include cleaning and cooking services, handbags and luggage, certain automobiles, and haute couture. Normal goods experience an increase in demand when incomes increase. If their incomes rise and they have a few extra dollars to spend each month, they may choose to buy organic bananas.

This occurs when a good has more costly substitutes that see an increase in demand as the economy improves. For inferior goods, the income elasticity of demand is negative, and the income and substitution effects work in opposite directions. When your income decreases, do you purchase more of a particular good or service? Perhaps you would buy second-hand clothes at a thrift store, or, example of inferior goods if you needed a car, you would buy a used car rather than a new car.

1. For example, if the consumer’s income increases and he prefers to replace his Single-Door Refrigerator with French door style refrigerator, then the demand for Single-Door Refrigerator will fall.
2. For normal economic goods, when real consumer income rises, consumers will demand a greater quantity of goods for purchase.
3. On the other hand, countries like German and Japan are well known to produce normal and superior products, especially in the motor industry.
4. Grocery store brand products provide an insightful example of how inferior goods are not necessarily of lower quality.
5. When people’s incomes are low, they may opt to ride public transport.
6. Individuals may be less likely to eat out, especially at fancier restaurants, in favor of inferior methods of having food prepared such as preparing the meal at home on their own.

A quick primer on inferior goods where the income elasticity of demand following a change in real income will be negative. Besides change in the prices of related goods and the income of the consumer, a commodity’s demand curve also shifts because of various other factors. If there is an increase or decrease in the consumer’s income, it inversely affects the given commodity’s demand. If there is an increase or decrease in the consumer’s income, it directly affects the given commodity’s demand.

Chapter 9: Forms of Market

Using a bus is an example of an inferior service if you would prefer to use a taxi. Instead, economists use inferior to describe the relationship between the demand for a good and a change in a consumer’s income. In economics, the demand for inferior goods decreases as income increases or the economy improves. When this happens, consumers will be more willing to spend on more costly substitutes.

Inferior Good: Definition, Examples, and Role of Consumer Behavior

Many Giffen goods are considered staples, especially in areas where people live in a lower socioeconomic class. When the prices of Giffen goods increase, consumers have no choice but to spend a larger amount of money on them. So they may spend more money on rice because that’s all they can afford to buy—even if the price keeps rising. Products such as meat, on the other hand, become luxuries, as they are far too unaffordable and out of reach. One notable aspect that must be considered here is that inferior goods do not imply that the quality of the good is inferior.

Do Inferior Goods Have an Inferior Quality?

Likewise, goods and services used by poor people for which richer people have alternatives exemplify inferior goods. Typical examples of inferior goods include “store-brand” grocery products, instant noodles, and certain canned or frozen foods. Although some people have a specific preference for these items, most buyers would prefer buying more expensive alternatives if they had the income to do so. Therefore, when incomes rise, demand for these items tends to decrease accordingly.

Elasticities of Demand MCQ Revision Question

In other words, inferior goods are those whose price elasticity is negative, but this doesn’t always involve a lower quality. As consumers’ incomes increase, they tend to decrease their purchases of inferior goods, opting for normal goods or luxury goods instead. The goods whose demand increases when there is an increase in the income of the consumer are known as Normal Goods. Besides, in general, consumers purchase more of normal goods when their income increases and purchase less of these goods when their income falls. For example, if demand for a Refrigerator increases with an increase in income, then the Refrigerator will be said to be a normal good.

Demand for inferior goods tends to decrease as consumer income increases, because as consumers have more disposable income, they are able to afford higher quality or higher value alternatives. An inferior good is an item that is often a substitute product whose demand drops when people’s income increases. During economic prosperity, consumers may be more likely to invest in more luxury goods. If a consumer’s income drops, they are more likely to resort to activities such as buying lower-quality items, generic brands, avoiding traveling, or changing eating habits.

1. Most governments will tax traders dealing with inferior goods more leniently as compared to those selling normal goods.
2. As consumers’ incomes increase, they tend to decrease their purchases of inferior goods, opting for normal goods or luxury goods instead.
3. For example, the price of second-hand clothes is lower than that of new clothes.
4. Consumers will generally prefer cheaper cars when their income is constricted.
5. Using a bus is an example of an inferior service if you would prefer to use a taxi.

Groceries are among the most common examples of inferior products because food is a necessity that must always be acquired. As opposed to eating a steak for dinner, an individual may opt for an inferior product such as canned meat or frozen food. When the economy is not so good and consumer have less budget, they usually buy products that do not have high utility; people tend to settle on products that are low in price or utility. In the above graph, the income of the consumer is shown on Y-axis, and the demand for an inferior good (say, Single Door Refrigerator) is shown on X-axis.

The substitution effect also plays a role in how consumers spend their income in times of rising or declining income. If all prices fall, known as deflation and nominal income remains the same, then consumers’ nominal income can purchase more goods, and they will generally do so. The characteristics of the good impact whether the income effect results in a rise or fall in demand for the good. Inexpensive foods like instant noodles, bologna, pizza, hamburger, mass-market beer, frozen dinners, and canned goods are additional examples of inferior goods. As incomes rise, one tends to purchase more expensive, appealing or nutritious foods.