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A good is normal if demand increases with income (positive income effect), and inferior if demand decreases with income (negative income effect). For a price decrease, the income effect on a normal good reinforces the substitution effect, but on an inferior good it opposes it. When income effect is large enough, a Giffen good (inferior good with income effect exceeding substitution effect) exhibits upward-sloping demand.
Compare demand curves for normal goods (rightward shift when income rises) versus inferior goods (leftward shift). Plot budget lines and indifference curves at different income levels.
You already know from income elasticity that demand responds to income changes — the question is whether it responds positively or negatively. This classification, seemingly simple, has deep implications for how demand curves behave when prices change and why some markets defy intuition.
A normal good is one where demand rises when income rises — the income effect is positive. Most goods fall into this category: more income leads to more restaurant meals, more travel, better electronics. An inferior good is one where demand falls when income rises — the income effect is negative. The word "inferior" carries no objective quality judgment; it describes a behavioral relationship. Classic examples include bus rides (replaced by car ownership as incomes rise), instant noodles (replaced by fresh ingredients), or generic store brands (replaced by name brands). Inferiority is always relative to an income range: a good can be inferior at moderate incomes and normal at low incomes where it is still an upgrade.
Within normal goods, income elasticity captures the degree of response. Luxury goods have income elasticity greater than 1: their share of consumer budgets grows as income rises (fine dining, sports cars, designer goods). Necessity goods are normal but with elasticity between 0 and 1: demand rises with income but less than proportionally, so their budget share actually shrinks (basic food, utilities, transportation). These distinctions matter for understanding consumption patterns across income levels and for forecasting how markets grow as economies develop.
The key analytical application is decomposing price effects. When the price of a normal good falls, both the substitution effect (toward the cheaper good) and the income effect (toward the now-real-income-enriched good you want more of) push demand up — the demand curve unambiguously slopes downward. When the price of an inferior good falls, the substitution effect pushes demand up but the income effect pushes demand down, since the real income gain makes the consumer want less of it. In virtually all real cases the substitution effect dominates and demand still rises. The extreme theoretical case — the Giffen good — is an inferior good where the income effect is so powerful that it overwhelms the substitution effect entirely, producing an upward-sloping demand curve. This is not a paradox; it is the logical endpoint of understanding how income and substitution effects interact when they point in opposite directions.