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What is the Income effect? Explain using the context of the liquidity preference framework

What is the Income effect? Explain using the context of the liquidity preference framework

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Answer) Liquidity preference theory suggests that an investor should demand a higher interest rate or premium on securities with long-term maturities that carry greater risk because, all other factors being equal, investors prefer cash or other highly liquid holdings. The income effect is related to economic concepts in consumer choice theory. The income effect expresses the impact of changes in purchasing power on consumption, As the income of individuals increases then they will be ready to take a risk in investing in the risky assets and if they are risk-averse then they will invest in the assets which give the returns with certainty and vice-versa. As investing in risky assets demand high rate of interest and investing in non-risky assets demands lower interest rates.

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