PRICE EFFECT/Next/Next

	Activity
This activity involves viewing of few cartoons, graphics and vedios on price rise in India, in the year 2011. This exercise will help you understand the impact of price rise on consumer's demand behaviour. [1] [2] [3] [4] costly in 2010

Case Study

The case studies that are discussed here suggest how understanding the impact of price change on consumption is important in economic analysis. (1)Global Hunger Index -2011. Rise in food prices adversely affect consumption. It is a serious concern when poor are affected the most. According to Klaus von Grebmer, lead author of the report on 'Global Hunger Index - The Challenge of Hunger:Taming Price Spikes and Excessive Food Price Volatility', "The poorest and most vulnerable people bear the heaviest burden when food prices spike or swing unpredictably,". For further details refer: [5] [6] (2)Rising Petrol Prices and Lowering of Car Sales in India. Car sales increase in the months of October, November and December in India as it is a festival time in India. However, the festival season for the year 2011 failed to attract buyers and revive the market demand for cars. This case study is about lowering sales of cars reported by all major auto manufacturing companies on account of rising petrol prices and expensive loans in 2011. For further details refer [[7]] Studies on comparative price of petrol in various countries suggested that petrol costs more in India compared to some of the neighbour countries, such as Pakistan, Bangladesh and Srilanka. It was even dearer in India than in the U.S. Analyst criticized the Indian government for the skewed tax structure on petrol and diesel. For further details refer [[8]]

Key Terms

Price Effect represents consumer's movement on her/his indifference map from one optimal consumption combination to another as a result of change in the price of a good and thereby changes in consumer's quantity purchased, price of another good and consumer’s income remaining unchanged.

In the words of Lipsey," The price effect shows how much satisfaction of the consumer varies due to the change in the consumption of two goods, as the price of one changes, the price of the other and money income remains constant."

Positive Price Effect is obtained in the case of normal goods. It represents consumer's movement on her/his indifference map from one optimal consumption combination to another as a result of change in the price of a normal good and thereby changes in consumer's quantity purchased, price of another good and consumer’s income remaining unchanged.

In this case changes in the quantity demanded of a good is inversely related to its price changes.

Negative Price Effect is obtained in case of inferior goods (including Giffen goods). It represents consumer's movement on her/his indifference map from one optimal consumption combination to another as a result of change in the price of an inferior good and thereby changes in consumer's quantity purchased, price of another good and consumer’s income remaining unchanged.

In this case changes in the quantity demanded of a good is directly related to its price changes.

Zero Price Effect is obtained in case of neutral goods. It represents consumer's movement on her/his indifference map from one optimal consumption combination to another as a result of change in the price of a neutral good and thereby changes in consumer's quantity purchased, price of another good and consumer’s income remaining unchanged.

In this case there are no changes in quantity demanded of the neutral good as a result of price changes.

Price Consumption Curve is obtained by joining the optimal consumption combinations of the consumer attained on the indifference map at alternative prices of a good. The PCC is a locus of a point that passes through optimal consumption combinations attained at alternative prices of one good in the combination, price of another good and consumer's income remaining unchanged.In other words, a PCC traces changes in consumer's optimal consumption combination as a result of the price effect.

Results

• People respond to price changes in order to maximize the utility of spendable income. The price effect represents changes in optimal consumption combination on account of changes in prices of goods.

• In term of indifference curves, a consumer is better-off when optimal consumption combination shifts on a higher indifference curve and vice versa, as a result of a price change.

• Consumer’s responses to price changes vary depending upon the nature of goods.

• Price effect is positive, negative and zero for normal goods, inferior goods and neutral goods respectively.

• The varying responses of a consumer for normal goods, inferior goods and neutral goods to price changes are important determinants of different forms of market demand curves.

Further Readings

(1) Essays in Honour of Malcolm Sawyer Edited by Philip Arestis

(2)› Visit Amazon's Dominick Salvatore Page

(3)Bradley R. Schiller (2011)The Micro Economy Today (11Edition) Tata McGraw-Hill

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