Question

How are equilibrium price and quantity affected when income of the consumers increase.

Answer 1

 Increase in income of consumers

If the number of firms is assumed to be fixed, then the increase in consumers’ income will lead the equilibrium price to rise.

Let us understand how it happens:

D₁D₁ and S₁S₁ represent the market demand and market supply respectively. The initial equilibrium occurs at E₁, where the demand and the supply intersect each other. Due to the increase in consumers’ income, the demand curve will shift rightward parallelly while the supply curve will remain unchanged. Hence, there will be a situation of excess demand, equivalent to (q^e − q₁). Consequently, the price will rise due to excess demand. The price will continue to rise until it reaches E₂ (new equilibrium), where D₂D₂ intersects the supply curve S₁S₁. The equilibrium price increases from P^e to P₂ and the equilibrium output increases from q^e to q₂.