Question

Explain the income effect of a fall in the price of a commodity on its demand.

Answer 1

The income effect occurs when the price change affects consumer purchasing power and thus leads to a change in the quantity demanded. When the price of a commodity falls, the consumer can buy a larger amount of the commodity with his given money income. Or, he can buy the same amount of the commodity as before and at the same time he would be able to save some money. In other words, a fall in the price of the commodity results in an increase in real income, i.e., purchasing power of the given money income increases. A part of increased real income may be used to buy more of this commodity.