What is Positive, Zero and Negative Income Effects? – Explained!

Therefore, the income effect of salt in this case is equal to zero. This means that the consumer spends the same amount of his money income on salt and the additional money income is used to purchase other commodity.

ICC in case of commodities with zero income effect is vertical. Its income elasticity of demand is equal to zero, since with change in income of the consumer, the demand for commodity ‘X’ remains unchanged.

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Income consumption curve with zero income effect for commodity ‘Y’ will be horizontal indicating no change in the demand for this commodity in equilibrium, irrespective of any change in the income of the consumer (see Fig. 5.36 (b)). Income elasticity of demand for commodity ‘Y’ is zero.

The income effect is negative for those commodities, which are considered inferior (e.g., wheat maize, jowar, Bajra, cereals, vegetable oils, cotton clothes, etc.) by the consumer. For such commodities, with the increase in income of the consumers, the consumption of the commodity falls, as the consumer starts substituting superior commodities for them.

In other words, poor people cannot afford to purchase expensive superior commodities. But, when they become richer, they are in a position to shift their purchase towards more expensive superior commodities. A negative income effect is illustrated in Fig. 5.37.

In Fig 5.37 (a), with higher budget line A3B3, A4B4, A5B5, the demand for the inferior commodity (taken on the X – axis) declines from OX3 to OX4 and then to OX5 with the rise in the level of money income.

This is shown by relative positions of equilibrium points E3, E4 and E5. Point E5 lies to the left of point E4, which lies to left of point E3 indicating a lower quantity of commodity ‘X’, despite the fact that it (E5) is on a higher budget line and thus involves a higher income for the consumer.

The consumer instead, purchases more of superior commodity (shown on the Y-axis). The income consumption curve obtained by joining the successive equilibrium points in the figure bends towards Y-axis, as increased money income of the consumer beyond point E3 would reduce the demand for commodity ‘X’. Thus, ICC slopes backward (i.e., upward to the left), when commodity ‘X’ is an inferior commodity.

If, on the other hand, commodity shown on the Y-axis happens to be an inferior commodity, the income consumption curve slopes downward to the right and bends towards X-axis. Fig. 5.37 (b) illustrates this situation. In this figure, A1B1 is the initial budget line.

This line touches the indifference curve IC1 at point E1. Thus, this is the point of consumer equilibrium. When income of the consumer increases, prices remaining constant, the budget line has a parallel shift and the new budget line is A2B2.

This budget line touches a higher indifference curve IC2 at point E2 which is the new point of consumer equilibrium. With further rise in the consumer’s income, consumer is able to purchase OY3 quantity of inferior commodity ‘Y’ at equilibrium point E3. Till this point, the consumption of both the commodities rise with the increase in income of the consumer.

However, any subsequent increase in the income of the consumer reduces the consumption of inferior commodity (commodity X, in this case). This is indicated by the consumer equilibrium points E4 and E5, where the consumption of commodity ‘Y’ has declined from OY3 to OY4 and OY5, depicting negative income effect for inferior commodity ‘Y’.

It can be noticed from Fig. 5.37 (a) and 5.37 (b) that income effect for inferior commodity becomes negative only after a point. This shows that only at higher levels of income, some commodities become inferior and before that, changes in their demand behave like those of normal commodities.

In Fig. 5.37, income effect is positive for both the commodities upto point E2. Rising slope in Fig. 5.37 (a) shows that as income rises, quantity demanded rises more than proportionately for commodity ‘Y’ and less than proportionately for commodity ‘X’.

Thus, commodity ‘ Y’ is a luxury, while commodity ‘X’ is a necessity. Reverse is the case in Fig. 5.37 (b). However, beyond point E3, income effect is negative for commodity ‘X’ (Fig. 5.37 (a) and commodity ‘Y’ (Fig. 5.37 (b)).

For two commodity case, both of them cannot be inferior, since increased income needs to be spent. If both the commodities are inferior, there will be decrease in expenditure on the two commodities resulting in disequilibrium. Here, the consumer will be below the budget line. He will not be reaching in optimum position of equilibrium. However, the consumer may consume two normal or luxury gods.

It is important to note that indifference curves do not explain why a commodity happens to be an inferior commodity or why income effect for a commodity is negative. Indifference curves merely explain the inferior commodity phenomenon. It is the consumer’s scale of preferences which tell us whether a commodity is inferior or superior and when or why.

Accordingly, a set of indifference curves can be drawn. In the words of Ryan,

“Indifference analysis can never tell us why a commodity is inferior. Knowing that it is inferior indifference analysis describes this, it never explains. And it is our knowledge of economic behaviour of actual households that tell us what to describe.”