Indifference Curve Analysis - Price Effect

Meaning: When there is no change in the income of the consumer, no change in the price of one commodity, and there is a change in the price of another commodity, there will be a change in the consumption made by the consumer. This change in consumption is known as the Price Effect. Though money income does not increase, the real income increases, generating more purchasing power.

Equilibrium position: Under the Price Effect, there will be a change in the equilibrium position of the consumer. This can be shown in the following diagram.


In this diagram PCC is the Price Consumption Curve. It is sloping downwards to the right. Any point on the Price Consumption Curve will indicate the equilibrium position of the consumer under the Price Effect. In this diagram when the price of X falls, the consumer purchases more of X and less of Y.

Shapes of Price Consumption Curve

With a fall in the price of one commodity there will be some extra income with the consumer. It can distribute this real extra income on the two commodities in different ways. So the Price Consumption Curve will have different shapes. Below we draw the different shapes of the Price Consumption Curve.



















In the above diagram PCC is the price consumption curve. It is a horizontal straight line. It indicates that with a fall in the price of X, the consumer purchases more of X and the same quantity of Y



















In the above diagram PCC, the price consumption curve, is sloping upwards to the right. This indicates that with a fall in the price of X the consumer purchases more of X and more of Y.

In this diagram the price consumption curve is sloping upwards to the left. This indicates that with a fall in the price of X, the consumer purchases less of X. This is applicable in case of Giffen goods.

Mr.Robert Giffen, made a survey in Ireland in the 19th century and found out that the people of Ireland spent major portion of their income on potatoes and meat. He also observed that when there was a rise in the price of potatoes, people purchased more potatoes. Because they did not have sufficient income to purchase sufficient quantity of meat and potatoes. Since potatoes were more essential to them, they purchased more potatoes and less meat. So those commodities, which are purchased more even when there is a rise in the price, they are known as Giffen goods.

Substitution Effect will be posted in a few days.

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