What is the income effect?

The income effect refers to the change in the quantity demanded of a good or service that results from a change in a consumer's real income or purchasing power, typically caused by a change in the good's price. When the price of a good decreases, consumers have effectively more purchasing power, which can lead to an increase in the quantity demanded of that good. Conversely, if the price increases, consumers may feel poorer and purchase less of that good, even if their actual income hasn't changed.

In an economic context, this effect illustrates how consumers adjust their consumption based on affordability. It highlights the relationship between price changes and consumer behavior, which is foundational to understanding demand in economic theory. The other options do not accurately encapsulate the definition of the income effect: they either refer to preferences, income changes unrelated to prices, or impacts on government finances, which are separate concepts.