The Price Effect

The effect of a change in the price of a commodity on its purchase is known as the price effect. The Price Consumption Curve (PCC) traces the price effect. Suppose the price of oranges falls while the price of bananas remains unchanged. The effect of such a fall in the price of oranges will be:

  1. The fall in the price of oranges will result in a rightward shift of the price line. A new price line will slope more towards the X-axis showing that the consumer can now buy more of oranges on account of the fall in their price.
  2. This fall in the price of oranges also implies rise in the real income of the consumer, though his money income remains unchanged. This means that he will be able to buy more of oranges on account of the fall in their price. This phenomenon is referred to as income effect.
  3. The Comparative cheapness of oranges vis-à-vis bananas will induce him to substitute oranges of or bananas. In other words, the consumer will now buy more of oranges on account of their relative cheapness. This phenomenon is referred to as the substitution effect. Thus the consumers demand for oranges will increase on account of the combined operation of income effect and the substitution effect.

The price effect has been illustrated in the Fig. The initial point of equilibrium of the consumer is at Q. Then the price of the oranges falls down. His new price line will be AB. this new price line is tangent to the next higher indifference curve IC2 at Q1. The consumer is now in equilibrium at the point Q1 where he buys OM1 oranges and ON1 of bananas. It is obvious that his purchase of oranges has increased by MM1 consequent upon the fall in their price. A further fall in the price of oranges will make the price line rotate anti clockwise. The new price line will be AB2 and the new position of equilibrium will be at Q2 with the consumer buying OM of oranges and ON2 of bananas. If we join together these various points of equilibrium, we obtain a curve known as the price Consumption Curve (PCC). This curve reflects the income and substitution effects of a change a rise or fall in the price of a commodity.

 

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