The Income Effect Reconsidered

18 Pages Posted: 15 Dec 2018

Date Written: November 23, 2018

Abstract

There is an avoidable tension in a recently presented argument against the income effect from the perspective of Austrian or causal-realist price theory. The argument holds that a constant purchasing power of money is a necessary assumption for constructing an individual demand curve for a specific good, and hence that price changes along the demand curve are by definition incapable of exerting a “purchasing power effect,” that is, an income effect in standard neoclassical terminology. Price changes are, however, never neutral to the purchasing power of money. We show that the necessary assumption for the construction of a demand curve for a specific good is not the constant purchasing power of money as such, but rather constant opportunity costs of expending money on the good in question. On this basis we show that it is possible to derive a type of income effect in causal-realist price theory. Yet, it might be more appropriate to call it a “wealth effect.” Regardless of important and undeniable differences, the gulf between neoclassical and Austrian microeconomics on this point is thus smaller than it has been made to be.

Keywords: income effect, wealth effect, causal-realist tradition, price theory, demand theory

JEL Classification: D11, B53

Suggested Citation

Israel, Karl-Friedrich, The Income Effect Reconsidered (November 23, 2018). Available at SSRN: https://ssrn.com/abstract=3289600 or http://dx.doi.org/10.2139/ssrn.3289600

Karl-Friedrich Israel (Contact Author)

Université catholique de l'Ouest ( email )

3 Place André Leroy
Angers, 49000
France

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