User:Rekham/DERIVATION OF DEMAND

MICROECONOMICS

PRICE EFFECT

Introduction

In the previous section we have seen how optimal consumption combination, the one that maximizes the utility of spendable income, is determined at the point where budget constraint is tangent to an indifference curve. In other words, the combination at which marginal rate of substitution equals the price ratio, as explained in User:Sanghamitra.

	Learning Objectives
After reading this chapter, you are expected to learn about: understand 3. How consumer’s optimal consumption in response to relative price changes confirms the law of demand?

Price Effect

| DERIVATION OF THE CONSUMER’S DEMAND CURVE

Figure XXX.1, depicting price effect establishes consumer’s demand behavior. When the price of good X increases, as depicted by the budget constraint PL_1, the consumer reduces consumption of good X (OX₁). Similarly, when the price of good X decreases, as depicted by the budget constraint PL_2, the consumer increases consumption of good X (OX₂).

In other words, Figure XXX.1 confirms the law of demand. This is shown in Figure XXX.2. Points a, b and c correspond to quantity demanded of good X corresponding to its price at optimal consumption combinations e₁, e and e₂ respectively.

|- | Figure XXX.2