Question

What is meant by the income effect of a fall in the prices of a commodity?

Answer 1

The income effect implies a change in demand due to a change in consumers real income resulting from a change in the price of a commodity. As the price of a commodity decreases, the real income of the consumer (i.e., income in terms of goods and services) increases. When the price of a commodity falls, the consumer has to spend less on the purchase of the same quantity of that commodity. With the money thus saved, a consumer can buy more quantity of that commodity. On the other hand, his real income would fall in case of a rise in prices. Hence, he will be in a position to buy less of the commodity when its prices rise (due to his decreased purchasing power).