The change in spending behavior when income changes is known as which effect?

• A. Cross-price elasticity
• B. Complementary effect
• C. The income effect
• D. The price elasticity of demand

Answer: (C)

When income changes, purchasing power changes and so does how much people can buy, even if prices stay the same. That shift in spending caused solely by a change in income is the income effect. For normal goods, higher income leads to more spending and higher quantities demanded; for inferior goods, spending on those goods may rise less or fall as income grows, with people opting for higher-quality substitutes. This is different from how demand responds to the price of the good itself (price elasticity) or to the price of other goods (cross-price elasticity). The key idea is that the change in income, by changing what you can afford, alters overall spending behavior.