Question

Increase in price of a product reduces the purchasing power as a result of which demand for a product goes up. This effect is known as __________.

• A. substitution effect
• B. income effect
• C. diminishing marginal utility concept
• D. law of diminishing returns

Answer 1

The correct option is B income effect

Income effect refers to the effect in the real income of the public due to increase in the price of the product. Real income refers to the portion of income of the public which is spent on consumption of goods and services in the economy. If the prices of products is increased in the economy it reduces the purchasing power of the public because with the same real income now people are not able to buy the same amount of goods as a result of which demand for a product goes up which is nothing but increase in the real income of the public.