Income Effect When Wheat is an Inferior Good: • Sometimes it also happens that with the rise in income, the consumer buys more of one commodity and less of another. For instance, he may buy less of wheat and more of rice as is, illustrated in figures 3.13.
116 INCOME EFFECT Cont….
117 INCOME EFFECT Cont…. • In diagram 3.13, the income consumption curve bends back on itself. With the rise in income, the consumer buys more of rice and less of wheat. • The price effect for rice is positive and for wheat is negative. The good which is purchased less with the increase in income is called inferior good.
118 INCOME EFFECT Cont…. Income Effect When Rice is an Inferior Good:
119 INCOME EFFECT Cont…. • In the figure 3.14, it is shown that with the rise in money income, the purchase of wheat has increased from M1 to M4 indicating positive income effect on the purchase of normal good wheat. • The income effect on inferior good is negative. The income consumption curve ICC is starts bending towards the horizontal axis which shows that wheat is a normal good and rice is inferior good.
120 PRICE EFFECT • Price Effect on the Consumption of a Normal Good: • We now discuss the reaction of the consumer to the changes in the price of a good while his money income, tastes, preferences and prices of other goods remain unchanged. • When there is change in the price of a good shown on the two axes of an indifference map, there takes place a change in demand in response to a change in price of a commodity, other things remaining the same, is called price effect.
121 PRICE EFFECT Cont….
122 PRICE EFFECT Cont…. • For example in fig. 3.15, AB is the initial budget line. It is assumed that the price of wheat has fallen and the price of rice and the income of the consumer remains unchanged. The price line takes a new position AC and the equilibrium point shifts from P to U. • The consumer buys now OT quantity of wheat (the amount demanded rises from OE to OT and OZ quantity of rice. With further fall in the price of wheat, the consumer is in equilibrium at point S, where the budget line AD is tangent to a higher indifference curve AC3.
123 PRICE EFFECT Cont…. • He buys now OF quantity of wheat and OR quantity of rice. • The rise in amount purchased of wheat (OE to OF) as a result of a fall in its price is called price effect. • The price effect on the consumption of a normal good is negative. If we join the equilibrium points PUS, we get price consumption curve (PCC) of the consumer for the commodity wheat.
124 PRICE EFFECT Cont…. Price Effect When Commodity X is a Giffen Good: • Giffen good is a particular type of inferior good. When there is a decrease in the quantity demanded of a good with a fall in its price, the good is called Giffen good after the name of Robert Giffen.
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- Fall '19