The effect of a change in the consumer’s income on his total satisfaction is known as income effect. A consumer will be able to enjoy more or less satisfaction when his income increases or decreases assuming that the prices of goods he purchases remain constant. Every increase in income brings him down to a lower indifference curve. The Income consumption Curve (ICC) traces the income effect.
Let us suppose consume is in equilibrium at the point R in the gives figure. Then his income increases with prices of oranges and bananas remaining the same. As his income increases, the budget line shifts upwards to the right. A1 B1 A2 A3 B3 indicates the new budget or price lines, respectively. These price lines are parallel to each other, the reason being that there is no change in the prices of the two commodities. Only the money of consumer has increased. The increase in income enables the consumer to purchase larger quantities of both the commodities. With higher income price lines the consumer will obviously move on to higher indifference curves. The initial position of equilibrium was at R but with the increase in income the consumer reaches new positions of equilibrium at points such as R1, R2, R3 etc. By joining together those points of equilibrium we obtain a curve known as income Consumption Curve (I.C.C)
This curve shows the relationship between changes in money income and consumption of the two commodities. This curve shows how consumption of the two commodities reacts to changing income when prices are assumed to be constant. Most income consumption curves slope upwards to the right indicating that as the consumer’s income increase she buys more of both the commodities. But this need not be so in all cases. Sometimes the income increase in consumer’s income, the consumption of the commodity increases while that of the other diminishes. This has been shown in the Fig. Above. To start with, the consumer was buying OM of X and ON of Y. As his income increases he buys more and more of Y but less and less of X. This shows that the income effect in the case of Y is positive while in the case of X it is negative. Therefore, Y is a superior commodity while x is an inferior commodity.