INCOME EFFECT

It refers to the change in consumption patterns due to the change in purchasing power; the causes can be:

- increase in income,

- price changes, or

- currency fluctuations. 

For example, a decrease in the price of oil allows you to buy either more low quality oil, or a better oil for the same price, thus increasing utility of consumption. Goods typically fall into one of two categories: normal and inferior.  These categorizations relate consumption of a good with a particular individual’s income. The consumption of normal goods increases as the income increases, while inferior goods decrease as the income increases. Moreover, some goods can be normal or inferior only in certain ranges of an income spectrum.