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Definition of the Income Effect:
The income effect
is the concept that as the price of a good falls, consumers tend to not only purchase more of that product but also more of other products because of an increase in purchasing power.
The income effect occurs when the price of a good falls and consumers purchase more of that product and more of other products because of their increased purchasing power. Purchasing soft drinks on sale may enable the consumer to buy a few more bananas and remain within budget. Normally, the income effect is small, but occasionally it can be enormous. Many economists believe the refinancing boom of 2002 to 2004 prevented the US economy from entering a recession. It was common for homeowners to refinance their mortgages and save several hundred dollars each month. These savings enabled consumers to purchase more.