Price Effects
Price Effect in case of substitute goods and complementary goods and Derivation of Price Consumption Curve and Price Demand Curve
Price effect is the total effect on demand for a commodity due to a change in the price of the same commodity, other things remaining constant.
1. Price Effect in case of Substitute Goods:
Substitute goods are those goods in which there is a positive relationship between the price of one commodity and demand for another related commodity. In the absence of one commodity, another related commodity can be used because substitute goods satisfy the same want of the consumer. substitute goods can be perfectly substituted or closely substitute.
In the above figure, panel A, initially the consumer is equilibrium at point E1 where the budget line AB tangent indifference curve IC1. The consumer consumes OX1 units of x and OY1 units of Y. When the price of x decreases, remaining other things constant. The budget line swing towards the right. The consumer consumes OX2 units of X and OY2 units of Y. Also, the consumer substituted Y1Y2 units of Y for X1X2 units of X. Similarly, when the price of X commodity again decreases remaining other things constant, the budget line rotates to the right from B1B1, the consumer consumes OX2 units of X and OY3 units of y for X2X3 units of Y. By joining all these three equilibriums E1E2 and E3, we derived a downward sloping price consumption curve.
In the above figure, in panel B, by joining all three equilibrium points ‘ABC’, we derived the price demand curve of X. At point A, the consumer consumes OQ1 units of X at OP2 price. Similarly, the consumer consumes OQ2 units at the OP1 price. And at point C, the consumer consumes OQ3 units at OP1 price.
2. Price Effect in case of Complementary Goods:
Complementary goods are those goods in which there is an inverse relationship between the price of one commodity and demand for another commodity. In the absence of one commodity, other complementary goods become useless. In the case of complementary goods, the price consumption curve slopes upward to the right as illustrated in the following diagram;
In the above diagram in panel A, initially, the consumer is at equilibrium at the point E1 where the budget line AB tangent to indifference curve IC1 at a point E1 where the consumer consumes OX1 units of X and OY1 units of Y commodity. When there is a fall in the price of X commodity, other things remaining constant, the budget line rotates rightward to AB1 which is tangent to the higher indifference curve IC2 at a point E2 where the consumer has increased the consumption of X from OX1 to OX2 and consumption of Y from OY1 to OY2. As the goods of X and Y are complementary to each other, the consumer has increased the consumption of both commodities when he moves from the equilibrium point E1 to E2. It is the price effect in the case of complementary goods. Again, when there are monetary goods. Again, when there is a further fall in the price of X, the consumer moves from the equilibrium point E2 to E3 with more quantities of both goods. By joining all these equilibriums points E1, E2, and E3 together by a smooth line, we derive an upward sloping price consumption curve (PCC).
On the basis of three equilibrium points E1, E2, and E3 in panel-A, three points A, B, and C respectively are plotted on panel-B. Here the point A represents the OX1 quantity of X demanded at the OP2 price. Point B shows OX2 units of X demanded at the price OP1 and similarly point C shows OX3 units of X demanded at the price OP0. Here, the price of X falls from OP2 to OP1 to OP0, the quantity demanded of X rises from OX1 to OX2 to OX3 respectively. By joining all these points together by a smooth price demand curve of X good which is complementary of Y.
