What happens to demand when income increases?

Use a supply and demand graph to illustrate the effects that an increase in income. What happens to the quantity of output? equilibrium price?

The impact that an increase in income has on demand is illustrated in the supply and demand diagram above. Usually, the increase in income leads to consumers wishing to spend more of their income on the good. This type of good is called an 'normal good'. In this case, it causes the demand curve to shift to the right, as for each price level consumers will be willing to purchase more goods than before.

For example, suppose you have an income of $50,000 and you go on 1 holiday per year which costs$1,000. Now suppose that you income increases to $100,000 - assuming you like going on holidays, do you think you would go on more or less holidays at the price of$1,000? Given that you are now going on more holidays for the same price, we need to move the demand curve to the right to reflect this fact.

The increase in demand has no impact on suppliers capacity to produce output. However, the increase in demand causes consumers to demand more output at the current price. This pushes the prices up from $P_1$ to $P_2$ which entices new firms to enter the market and produce output. The quantity consumed increases from $E_1$ to $E_2$. Therefore, the increase in income causes the demand curve to shift to the right, causing the price and quantity to increase.

Sometimes an increase in demand does not lead to an increase in demand. These goods are called 'inferior goods'. An example of an inferior good might be spam. As peoples incomes increase, they might decrease their consumption of spam and replace it with better quality meat. In this case, the demand for the good would actually decrease. I will leave it to the reader to determine what happens to the demand curve of an inferior good when a consumers income increases!