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