The income effect explains how a change in the price of a product affects a consumer’s purchasing power (or real income). When a price changes, a consumer effectively has more or less money to spend, which changes the amount of goods they decide to buy.

When the price of a product drops, a consumer has more spending power. This allows them to buy more of that product or other items.

How it works:

• Price drops: The product becomes cheaper.
• Purchasing power rises: The consumer can buy the same amount of goods for less money.
• Behavior changes: The consumer decides how to use this extra buying power to purchase more goods.

Normal vs. Inferior Goods:

• Normal good: When the price falls and real income rises, people buy more of the product.
• Inferior good: When the price falls and real income rises, people buy less of the product because they prefer to switch to higher-quality alternatives.

Simple Example:

If the price of a movie ticket decreases, you have more money left over after buying your ticket. Because you are effectively richer, you might choose to see movies more often. This change in your behavior caused by having more real income is the income effect.