CONSUMER BEHAVIOUR ANALYSIS(EQUILIBRIUM)

CONSUMER BEHAVIOUR ANALYSIS

source: google images

We will be studying 4 different cases of shift in equilibrium through indifference curve approach. But before we start u should know the following things:

Price elasticity of a good through expenditure method;

  1. When elasticity denoted by Ep is less than 1 then there exists a direct relationship between price and total expenditure.
  2. When Ep > 1 then there is an inverse relationship between them i.e. they move in opposite directions.
  3. Ep=1 the expenditure remains same irrespective of prices.

Pivotal shifts

The one sided shift of budget line is known as pivot shift i.e. either the point on x axis or on y axis shifts from its position.

source: google images

These two points remain common in all cases

  • The fall in prices causes a pivot shift of budget line on x axis towards right. (B to B)
  • The new position of indifference curve depends upon the price elasticity of good x

CASE 1

   

Ep < 1 and price of good x falls

  • As in this case there is a direct relationship between price and expenditure the fall in prices lead to increase in demand for good x but decrease in expenditure simultaneously.
  • This decrease in expenditure leads to excess income which is now used to buy good y and hence increasing the demand or consumption for good y.
  • The new equilibrium must lie between P and Q as to the left of P demand for good x will fall which is not possible as it will break the law of demand and to the right of Q demand for good y will fall which is against our theory just proven in previous point.

 

Case 2

     

Ep > 1 and price of good x falls

  • As in this case there is an inverse relationship between price and expenditure the fall in prices lead to increase in demand for good x (x1 to x2) and a simultaneous increase in expenditure on good x.
  • This increase in expenditure reduces the available income and therefore we have to reduce quantity of good y (Y1 to Y2) and hence decrease its demand.
  • The new equilibrium must lie between P and Q as to the left of the quantity of good Y increases which will go against are deduction in previous point.

 

Case 3

   

  Ep = 1 and price of x falls

  • As in this case the expenditure on good x is independent of its price therefore a fall in price of x will have no effect on expenditure but the quantity of good x will increase with such an amount that it will nullify the effect of residual or increased income.
  • There will be no change in the quantity of good y .
  • The new equilibrium must lie at point E2 only so that quantity of x increases without any effect on quantity of y.

 

Case 4

    

Ep = 0 and price of good x falls

  • As in this case price elasticity is zero therefore a fall in prices will not-effect the quantity of good x
  • The residual income due to reduced prices of good x will now be absorbed by good y entirely leading to increase in quantity of good y
  • The new equilibrium must establish at point E2 to satisfy the condition of constant quantity of good x.

 

Case 5

Elasticity = infinity

This case does not exist in reality as price cannot change in this situation as the effect on demand due to change in price cannot be predicted.

 Savings For One But Inimical For The Economy (Paradox Of Thrift)

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