Income Effect And Its Effect On Income

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Income effect is when the income changes and it results in the change of the quantity demanded. In this situation we observe a rise in disposable income that will consequently increase the purchasing power of the households that means individuals can purchase more than before. This means that an increase in income results in increase of the demand if the good is a normal good like food & beverages. Normal good is a good for which the demand is increasing when the consumer’s income is rising and vice versa. Moreover, a change in income prompts the consumer to choose a new optimal bundle. The income effect of a rise in price can be negative or positive, depending on whether the good X is. Policy 1 does not have any substitution effect, it is a pure income effect. Graphs are illustrated in Appendix A17 Figures 4,5,6. The x1 and x2 values for policy 1 in comparison with no policy are nearly same that distinctly proves the fact that the net effectiveness of this policy is 0. Policy 2 is a taxation of the price of good x1 that is food & beverages. As far as we know that any debts on the price will increase the price, therefore the price for good 1 rises from £35.00 to £40.25. So when the price was taxed and the new price was introduced, we faced a shrinking rotating budget constraint line from BC* to BCI. Slutsky was the first economist who explored the total effect arisen from the price change of a good, hence the process of separating the total effect into the substitution
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