4.3.4 Consumer response to a change in income
We can now use our analysis to examine how consumers react to changes in income or
price. First, consider the impact of an income change.
As noted, an increase in money income, with constant prices, shifts the budget line
outwards in a parallel fashion. The consumer could now buy more of both goods and
reach a higher indifference curve. Real income has increased.
Figure 4.11 shows the effect of consecutive increases in income from I1 to I5. From an
initial equilibrium at point a, the consumer moves to a new equilibrium at b on a higher
indifference curve. Further increases in income move the consumer to points c, d and e
on progressively higher indifference curves.
A line joining the points of equilibrium in Figure 4.11 is known as an income consumption
curve (ICC). This is the locus of equilibrium points following a change in
income when prices are held constant. The slope of the ICC shows how the consumer
reacts to the change in income. In Figure 4.11, the ICC is positively sloped, indicating