Price effect

The price effect is the change in the quantity demanded of a good (or service) when its price is modified, while the rest of the variables remain constant (other prices, income or consumer preferences , among others).

When the price of a good changes, the conditions in which a particular consumption basket was chosen change. Given the above, the user will have to reevaluate their choice and will probably have to vary the quantity demanded of the goods that make up their basket.

Thus, for example, if the price of one of the goods falls, the consumer will see its budgetary restriction modified and can look for a new optimum in a higher indifference curve.

On the contrary, if the price of one of the goods increases, the budget line changes, but now the consumer can only aspire to a lower indifference curve. In addition, given a price change, the relative prices of goods also change.

Price effect components

The price effect consists of two effects: the substitution effect and the income effect. The first refers to the change in the quantity demanded exclusively caused by the relative change in the prices of the goods.

Likewise, the income effect refers to the change in the quantity demanded by the modification of the purchasing power due to the change in the price.

Price effect graph

We can see the price effect in the following graph. Suppose there are two goods 1 and 2, both are normal goods. The price of good 1 falls while the price of good 2 remains constant. Then, the amount that a consumer can now buy is M / P1 ′, because with the same money supply (M) he can buy more products if the price of the good falls.

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