Page 93 - DECO401_MICROECONOMIC_THEORY_ENGLISH

Microeconomic Theory

Notes
Fig. 5.2

P

Goods Y L B

A
R

O
S Q M
Goods X

Suppose that the price of X increases by keeping the price of Y, constant and then LS would be his new
price income line. Now suppose that he selects a new combination A which indicates that due to the price
rise of X, the consumer will buy less of product X. The real income of consumer is down by increasing
the price of product X, so LP is given to him in the form of product Y. Thus PQ is now his new price
income line which is parallel to LS and crosses from point R. Samuelson tells this Overcompensation
Effect. Now the selection region for consumer is triangle OPQ. Because R was preferable choice from
all the points on original price income line LM, so none of the points will match with the behaviour of
consumer on RQ of PQ line below to point R. So he cannot take more quantity of X if the price of X ups.
So the consumer will choose R or B on the shaded region LRP on price income line PQ of PR. If he selects
the combination R then he would buy the quantity of X and Y before the price hike of X. On other hand,
if he selects the combination B then he would buy more quantity of Y than X.
In second stage, if the LP packet is taken away from the consumer then he would be in the left side of
R on point A on LS line where he would buy lesser quantity of X, if the income elasticity of demand is
positive because the demand is less for X due to price rise (when consumer is on point A) and hence it
proves that when income elasticity is positive then price elasticity is negative.

(b) Fall in Price

The theory of demand can be proved when the fall of price happens with product X. This can be described
in these words as, “Any product (general or combined) whose demand decreases only when income
is low, must be high on demand when only its price gets low.” This is described in Fig. 5.3. LM is the
original price income line where consumer gives preferences on point R. His price line goes to LS if the
price of product X gets low but price of product Y is stable. Suppose that in this point, consumer reveals
preference for combination A, which indicates that he buys more quantity of product X. The movement
from point R to A has price effect due to price fall of product X and X demands high now.

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