Question

What is income effect?

Short answer

The income effect encourages a utility-maximizer to buy more of both goods if utility rises or less of both goods if utility falls.

Step-by-step solution

Step 1. Meaning of income effect

The income effect is the reduction in buying power that causes a shift from the higher indifference curve to lower indifference curve,with the relative price remain unchanged. The income effect encourages a utility-maximizer to buy more of both goods if utility rises or less of both goods if utility falls.