- Indifference Curve is a curve showing all the combinations of two goods (or classes of goods) that the consumer is indifferent as it gives him same level of satisfaction.
- Assumption
- Rational Consumer
- Ordinal Utility Non-Satiety (More is Preferred to Less)
- Diminishing Marginal Rate of Substitution.
- Consistency: If a consumer prefer A to B in one period then he will not prefer B to A in another period.
- Transitivity: If a consumer prefers A to B and B to C, then he must prefer A to C.
Income effect shows this reaction of the consumer. Thus, the income effect means the change in consumer’s purchases of the goods as a result of a change in his money income. Income effect is illustrated in Fig. 8.28.
The prices are given
The income is given
The Budget line is P1L1 and the consumer is in equilibrium at point Q1.
Now suppose the income of a consumer increases and the income line or Budget line shifts to P2L2. The new equilibrium point is Q2. and similarly if income further goes up he is at equilibriun at Q3 and Q4 indicating that as income goes up a consumer makes more purchases of both the goods. Such goods are called normal goods. If these points showing the equilibrium at various income levels are joined togather we get an income Consumption curve (ICC). Income effect is positive in case of normal good. However forsome goods income effect is negative. It means when income goes up consumer starts consuming less of that good. Such goods are called inferior goods.
Price Consumption Curve:
As a result of change in price of X good the Price line shifts to PQ to PQ1where the consumer is in equilibrium at point S. This means that he is purchasing more quantity of good X whose price has decreased. He has thus become better off, that is, his level of satisfaction has increased as a consequence of the fall in the price of good X. Suppose that price of X further falls so that PQ2 is now the relevant price line. the new equilibrium point is T.
Now if we join these equilibrium points we get Price Consumption Curve (PCC) Price consumption curve traces out the price effect. It shows how the changes in price of good X will affect the consumer’s purchases of X, price of Y, his tastes and money income remaining unaltered.
If we plot the price and quantity combinations in another diagram and join them we get a demand curve.
In the lower diagram we take price on vertical axis and quantity demanded on x axis. By plotting price and quantity demand of good X by the consumer we get demand curve for good X.
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In this topic there is some error.The right one will be this ,for normal goods income effect is negative.In case if income effect is positive then it is inferior goods.
ReplyDeletei have some explanation.when price of normal good increases then purchasing power of consumer falls so he will purchase less of that good.therefore as price increases then quantity falls.it is negative.total effect is also negative as subsitution effect is always negative regardless of the nature of the good.
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