Explain the rule for determini

Explain the rule for determining the sign of the income effectof a change in px on demand for x. Make sure to consider both thecase in which the individual is a net buyer of x and in which theyare a net seller of x.


The income effect: It is the change in demand for a good orservice caused by a change in a consumer’s purchasing powerresulting from a change in real income. This may happen if price ofgoods that consumer buys decreases. So consumer will be left withmore income.

If an individual is a buyer:

If the good is a normal good then increase in income willincrease its demand. Example- A brand new car. Hence there will bepositive sign. Income elasticty of demand will be positive.

Income elasticity of demand (Yed) : % change in quantitydemanded/% change in income

In this case, increase in income will increase demand.

If the good is a inferior good then increase in income willdecrease its demand. Example- A second hand car.

In this case, increase in income will decrease demand. Hencenegative sign.

If an individual is a seller:

If price increases then seller will supply more good. Hence, itwill have a positive sign due to law of supply. However, if a priceincrease is due to change in costs of raw material then sellerswill decrease supply and it will have a negative sign.

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