income effect

Definition

Change in the demand of a good or service, induced by a change in the consumers' discretionary income caused by an increase of decrease in the price of the item. Any increase or decrease in price correspondingly decreases or increases consumers' discretionary income which, in turn, causes a lower or higher demand for the same or some other good or service. For example, if a consumer spends one-half of his or her income on bread alone, a fifty-percent decrease in the price of bread will increase the 'free' money available to him or her by the same amount which he or she can spend in buying more bread or something else. It is one of the two effects caused by a price change, the other is substitution effect.