# Rekham/PRICE Effect2

Price Effect 2

| When the price of good X increases, the budget constraint then becomes steeper, as the lower end point moves leftward. This is depicted by budget constraint PL1. The optimal consumption is located at point e1 at which the consumer buys OX1 units of good X. Consumer’s total utility decreases as the equilibrium point is located on a lower indifference curve.

Similarly, when the price of good X decreases, the budget constraint becomes flatter, as the lower end point moves rightward. This is depicted by budget constraint PL2. The optimal consumption is now located at point e2, at which the consumer buys OX2 units of good X. Consumer’s total utility increases as the equilibrium point is now located on a higher indifference curve.

Whenever price of a good representing on X axis change, lower point of the budget constraint shifts, As such, consumer’s optimal consumption combination also changes. The consumer is better-off when optimal consumption combination is located on a higher indifference curve and vice versa.

Thus, the price effect represents change in consumer’s optimal consumption combination on account of change in the price of a good and thereby changes in its quantity purchased, price of another good and consumer’s income remaining unchanged.

|- | XXX.1.2 NEUMERICAL EXAMPLE | | PX = Rs.10 PY = Rs 5

- PX/PY = - 10/5 = - 2/1

 Combination Units of Onion X Units of Tomato Y MRSxy a 12 25 - b 13 18 -7/1 c 14 13 - 5/1 d 15 10 -3/1 e 16 8 -2/1 f 17 7 -1/1

Equilibrium combination is 16X + 8Y

Consumer spending (16*10 + 5*8 = 160 + 40 =200)

Price of X has increased to Rs.20, Price of Y Rs.5 Income Rs.200

- PX/PY = - 20/5 = - 4/1

For Same combination (16*20 + 5*8 = 320+40 = 360)

 Combination Units of Onion X Units of Tomato Y MRSxy a 5 22 - b 6 16 -6/1 c 7 12 - 4/1 d 8 9 -3/1 e 9 7 -2/1 f 10 6 -1/1

Equilibrium combination is 7X + 12Y

7*20 + 12*5 = 140 + 60 = 200

|- | XXX.2

TABLE XXX.1

Impact of fall in price of X on its purchase. |

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TYPES OF PRICE EFFECTS