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 PL_2. The optimal consumption is now located at point e_2, 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. |

| TYPES OF PRICE EFFECTS