What does the income effect illustrate?

The income effect illustrates how changes in the price of a good or service affect the purchasing power of consumers' income, subsequently influencing their behavior in terms of quantities purchased. When prices change, the real income of consumers—the amount of goods and services their income can buy—changes as well. If the price of a good decreases, for example, consumers can afford to buy more of that good (or other goods) with the same amount of income, potentially increasing the quantity demanded. Conversely, if the price increases, their purchasing power diminishes, leading to a reduction in demand.

While options focusing on the relationship between income and savings, the effect of inflation on purchasing power, or changes in demanded quantities in response to real income decreases highlight important economic concepts, they do not specifically capture the essence of what the income effect represents. The income effect is centered on understanding how price changes impact the effective income level of consumers and thus influence consumption patterns.