Income Effect
The income effect is the change in an individual's demand for a good that results from a change in their purchasing power. This effect occurs because an increase in income, or a change in a good's price, alters the feasible set of purchases. For instance, a price decrease or income increase expands the set, while a price increase or income decrease shrinks it. It is important to distinguish the income effect from the substitution effect, as a change in a good's price triggers both effects simultaneously.
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Introduction to Microeconomics Course
The Economy 2.0 Microeconomics @ CORE Econ
Ch.3 Doing the best you can: Scarcity, wellbeing, and working hours - The Economy 2.0 Microeconomics @ CORE Econ
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Income Effect
Substitution Effect
Activity: Disentangling Income and Substitution Effects of a Wage Rise
Dominance of Income or Substitution Effect Determines the Net Effect of a Wage Rise
Further Reading on the Mathematics of Consumer Choice
Key Sources for Historical Analysis of Work-Leisure Choices
Applying the Wage Effect Model to Explain Historical Labor Trends
Explaining Historical Labor Trends
An individual experiences a significant increase in their hourly wage. If the effect of the higher opportunity cost of free time on their choices is stronger than the effect of their increased overall purchasing power, what will be the most likely change in their behavior?
Analyzing Worker Responses to a Wage Increase
Policy Impact on Work-Leisure Choice
Following a wage increase, an individual's decision about how many hours to work is influenced by two opposing effects. Match each effect to its underlying cause and the behavioral incentive it creates.
Following an increase in an individual's hourly wage, the resulting 'income effect' and 'substitution effect' both create an incentive for the individual to work fewer hours.
A freelance software developer who was previously earning $50 per hour finds a new client who pays them $100 per hour for all the hours they are willing to work. After this change, the developer decides to reduce their working hours from 40 hours per week to 30 hours per week to spend more time on personal projects. Which of the following statements best explains the developer's decision?
Explaining Varied Worker Responses to a Wage Increase
Evaluating Employee Incentive Strategies
Analyzing Employee Overtime Decisions
Dominance of the Income Effect on Labor Choice
Dominance of the Substitution Effect on Labor Choice
Figure 3.16: Modeling US Work-Leisure Choices (1900 & 2020)
Activity: Analyzing the Impact of a €45 Wage on Karim's Choice Using Figure 3.9
A Wage Increase Steepens the Budget Constraint
An individual has 24 hours per day to allocate between leisure and work. Their initial wage is $20 per hour. Later, their wage increases to $25 per hour. Which of the following combinations of daily leisure and consumption was impossible at the initial wage but becomes possible after the wage increase?
Effect of a Wage Increase on Affordable Choices
True or False: When an individual's hourly wage rate increases, the expansion of their set of affordable choices means that their maximum possible hours of leisure per day also increase.
Analyzing the Impact of a Wage Increase on Choices
An individual who can choose between work and leisure receives an increase in their hourly wage. Arrange the following outcomes in the correct logical sequence that results from this wage increase.
An individual who can choose how many hours to work per day receives an increase in their hourly wage. Match each characteristic of their set of affordable consumption and leisure combinations with the correct description of how it changes as a direct result of the wage increase.
Analyzing the Effect of a Wage Increase on an Individual's Choices
An individual has 24 hours per day to allocate between leisure and work. If their wage increases from $15 per hour to $20 per hour, their maximum possible daily consumption, achieved by forgoing all leisure, increases from $360 to $____.
An individual who allocates their time between work and leisure receives a significant increase in their hourly wage. Considering the new, larger set of affordable consumption and leisure combinations that results, what is the most direct consequence for the trade-off this individual faces?
An individual allocates their 24 hours per day between work and leisure. They receive a significant increase in their hourly wage. Which of the following statements provides the most accurate analysis of how their set of affordable consumption-leisure combinations changes?
A Worker's Choice with a Higher Wage and Flexible Hours
Income Effect
Analyzing Karim's Choice After a Wage Increase to €45
Increased Welfare from an Expanded Feasible Set
A Wage Increase Leads to Higher Utility but Has an Ambiguous Effect on Work Hours
Income Effect
An individual's income increases, while the prices of all goods they consume remain constant. Even if this individual chooses to purchase the exact same combination of goods as before the income increase, why can we conclude their overall well-being has improved?
Evaluating Well-being Based on Available Choices
Comparing Welfare with Different Opportunity Sets
An individual receives a significant, unexpected inheritance, which increases their non-labor income. If this individual chooses to continue working the same number of hours and consuming the exact same bundle of goods as before the inheritance, it can be concluded that their overall well-being has not improved.
A consumer initially chooses to purchase a specific combination of goods. Subsequently, their income and the prices of the goods change in such a way that their original combination of goods is no longer affordable. Assuming their preferences have not changed, what can be concluded about the consumer's well-being?
Comparing Welfare-Enhancing Policies
A government is considering two different programs to assist a household, both of which have the same monetary value. Program A provides the household with a $500 cash payment. Program B provides the household with a $500 voucher that can only be spent on food. Assuming the household would normally spend some, but less than $500, of its own money on food, which statement correctly compares the potential impact of these two programs on the household's well-being?
An individual's preferences are assumed to be constant. Match each economic scenario with the most accurate conclusion about the change in the individual's set of affordable choices and their resulting well-being.
Evaluating Welfare After a Price Change
Welfare Change with a Rotated Budget Constraint
An individual receives a significant, unexpected inheritance, which increases their non-labor income. If this individual chooses to continue working the same number of hours and consuming the exact same bundle of goods as before the inheritance, it can be concluded that their overall well-being has not improved.
Learn After
The Income Effect of a Wage Increase on Free Time
Figures 3.11 and 3.12 as Illustrations of the Income Effect
The Assumption of a Non-Negative Income Effect
Graphical Representation of the Income Effect (Movement from A to C)
An Increase in Unearned Income Generally Leads to Higher Consumption and More Free Time
Impact of a Windfall on Consumer Behavior
Suppose the price of gasoline, a good that a commuter purchases regularly, falls significantly. As a result, the commuter finds they have more money left over after filling up their tank each week. They use this extra money to start buying a premium coffee on their way to work, a luxury they previously avoided. Which statement best explains the commuter's decision to buy the coffee?
Isolating the Purchasing Power Effect
An employee knows there is a consistent, but random, chance they will be caught if they decide not to put in effort during any given pay period. To decide whether the risk is worth it, they need to weigh the benefit of avoiding effort against the potential cost of being fired. According to the standard economic model for this situation, how should the employee approach calculating the total potential benefit of shirking?
The income effect refers to the change in the quantity of a good a person chooses to buy that results from that good becoming relatively cheaper or more expensive than other goods.
A consumer's favorite brand of coffee goes on sale, reducing its price by 50%. The consumer observes that they now have more money left in their weekly grocery budget. They use this extra money to buy more fresh fruit, a completely unrelated product. Which of the following statements best dissects the consumer's decision to buy more fruit?
Analyzing Consumer Response to a Subsidy
The price of concert tickets, a good that Sarah frequently purchases, decreases significantly. In response, Sarah not only attends more concerts but also starts buying more expensive merchandise at the concerts, something she rarely did before. Which part of Sarah's new behavior is explained exclusively by the change in her purchasing power?
A government program provides a significant, unconditional monthly cash payment to all its citizens. An economist studying the program's impact observes that, on average, recipients decrease their purchases of generic canned soup but increase their purchases of fresh, high-quality cuts of meat. Which statement provides the best evaluation of this change in consumer behavior?
An individual receives a significant salary increase. Following this raise, they begin to travel more frequently for leisure, even though the prices for flights, hotels, and other forms of entertainment have not changed. Which statement provides the most accurate economic explanation for this change in behavior?