Effect of An Increase in Consumer Income on The Demand for A Good

Changes in the purchasing power of various products are often determined by income changes, price changes, or currency fluctuations. With a product’s price decrease, consumer purchasing power is often increased. As such, it enables a consumer to purchase a better product or more of the same product at the same price taking into consideration an increase in consumers’ income (Horowitz & McConnell, 2003). However, these changes affect different goods and services in different ways. For instance, the demand for normal goods often increases with an increase in consumers’ income as well as a rise in consumers’ purchasing power. Conversely, inferior goods often experience a decline in demand whenever the consumers’ income increases. This often occurs when the inferior goods have more costly substitutes that create an increase in consumer demand as the consumers’ income increase.

Q2. Income-Expenditure Model

The income-expenditure model of economics was developed by John Maynard Keynes. Using this model, Keynes was trying to explain fluctuations in prices of goods and services, as well as consumers expenditure. The model states that with an increase in the production of goods to the consumer market, fluctuations in production and expenditure play an essential role in keeping the economy more stable (Frenkel & Johnson, 2013). There are several assumptions that Keynes made when constructing this model. He assumed that the price level is often fixed, there are no taxes, the outside models often determine the interest rates within an economy, there are no government expenditures, and that the suppliers will often supply the demanded products and services at a fixed price level.

Q3. Factors Determining Amount of Real GDP Demanded

Gross domestic product (GDP) is a way to measure a nation’s level of production or to determine the value of goods and services produced in the economy. Aggregate demand often shows how GDP is related to the price levels within an economy (Sutton, Elvidge, & Ghosh, 2007). GDP can also be determined or estimated using three methods such as measuring the total value of all goods and services that have been sold to the final users or consumers. Additionally, one can add together the income payments and other costs encountered during the production of various goods and services. Moreover, one can sum all the value added to the goods and services at various production stages.

Q4. Economy’s Potential Output and Factors Determining Potential Output

An economy’s potential output is defined as the amount and types of resources that are available in it, and how the economy uses efficiency to effectively utilize these resources to produce more goods and services. Resources within an economy as usually categorized into human and natural. Human resources play a significant role in improving the economy. For instance, an economy with educated workers often experiences a high potential output as these workers can do more complex work and add more value to the things they make or produce more quality products and services. As such, the economy’s potential output is increased rather than an economy integrated with uneducated workers leading to declining of potential output due to the production of low-quality products. Natural resources are also of significance to an economy. For example, a country that has large deposits of minerals and many rivers to generate hydropower would actually encounter high potential output. Moreover, efficiency in the economy determines the forms of technology and types of business organizations that are able to initiate effective utilization of the available resources (De Masi, 1997). Thus, an economy’s potential output is determined by the available resources and the ability to use these resources efficiently and effectively.




De Masi, P. (1997). IMF Estimates of Potential Output. Washington: International Monetary Fund. Retrieved from https://books.google.co.ke/books?hl=en&lr=&id=eRUM0xgsbsQC&oi=fnd&pg=PP5&dq=potential+output&ots=iXq9E0oSq0&sig=AQ9TD2WWBOBb0eeNd4SUFvM8RSo&redir_esc=y#v=onepage&q=potential%20output&f=false

Frenkel, J. A., & Johnson, H. G. (2013). The Monetary Approach to the Balance of Payments (Collected Works of Harry Johnson). Routledge. Retrieved from https://books.google.co.ke/books?hl=en&lr=&id=gJkQFhZZLvsC&oi=fnd&pg=PA222&dq=income+expenditure+model&ots=rrTzem9eGI&sig=wEQhCUnf6ch7qxnbH2nBzGUOpTY&redir_esc=y#v=onepage&q=income%20expenditure%20model&f=false

Horowitz, J. K., & McConnell, K. E. (2003). Willingness to accept, willingness to pay and the income effect. Journal of Economic Behavior & Organization51(4), 537-545. Retrieved from https://ageconsearch.umn.edu/record/197596/files/agecon-maryland-00-09.pdf

Sutton, P. C., Elvidge, C. D., & Ghosh, T. (2007). Estimation of Gross Domestic Product at Sub-National Scales Using Night-time Satellite Imagery. International Journal of Ecological Economics & Statistics8(S07), 5-21. Retrieved from https://www.researchgate.net/profile/Ghosh_Tilottama/publication/242254394_Estimation_of_Gross_Domestic_Product_at_Sub-National_Scales_Using_Nighttime_Satellite_Imagery/links/00b49532130d0ea7d1000000/Estimation-of-Gross-Domestic-Product-at-Sub-National-Scales-Using-Nighttime-Satellite-Imagery.pdf