Comparative Statics of Consumer Behavior
Comparative Statics of Consumer Behavior

Comparative Statics of Consumer Behavior

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Introduction

The theory of consumer behavior and demand is grounded on the assumption that consumers try to allot limited money income among available goods and services to maximize satisfaction. The consumer purchases to maximize satisfaction subject to the constraint that these purchases do not exceed the consumer’s limited money income. Thus, for the theory of consumer behavior, we assume that each consumer has a maximum amount that can be spent per time. The problem of the consumer is to spend this amount in a way that yields maximum satisfaction. The consumer’s budget line represents the limited budget available to them.  Similarly, we also assume the constant prices of the product in the consumption bundle for a given time. Any change in prices of the product and income available to the consumer results in the simultaneous change consumer’s consumption decisions. In our analysis, we are interested in comparative statics of consumer behavior- changes in quantities purchased resulting from a change in price and money income. The changes are graphically represented by shifts in the budget line.

Consider the increase in money income from M to M*>M, money prices remaining unchanged. The consumer can now purchase more or more of good X and Y or both (here good X and Y are two goods in the consumption bundle). The solution to the consumer’s preference problem or consumer’s optimization problem ensures the equilibrium units of good X and good Y and based on consumer preferences, prices, and money income. This satisfied the existence theorem. On the other hand, the differentiability of the indifference curves and the linearity of the budget constraint imply that the optimal bundle will vary continuously in response to changes in price and income and that demand functions are differentiable. The linearity of the budget line and non-linearity of the indifference curve ensures a stable and unique equilibrium.

Now under the title comparative statics of consumer behavior, we investigate the effects of changes in exogenous variables like prices, and money income on the equilibrium values of the endogenous variables like the consumer’s demand for goods. So, we will get the answer to what happens to the optimal bundle of good x*= (x*1, x*2…., x*n) = (D1, D2…., Dn) as the feasible set varies with varies in prices and money income.

The comparative statics of consumer behavior is explained as below;

Effect of Change in Consumer’s Income in the Equilibrium Position

When there is an increase in the income of the consumer, it will shift the budget line and the feasible region also changed. This shift in budget line affects the consumer’s equilibrium or consumer choice. This effect in equilibrium due to the change in the income of the consumer, other things remaining the same is the income effect.  Thus, there is a positive effect of change in income in the consumer’s equilibrium. The following table shows a summary of the income effect in the case of different goods.

Types of GoodsIncome EffectInterpretationNature of ICC Curve
Normal Good∂Xi/∂M>0 Positive EffectChange in income positively effect on the consumption of goodUpward sloping ICC
Inferior Good∂Xi/∂M<0 Negative Effect  Change in income negatively effect on the consumption of goodBackward or downward bending ICC
Neutral Good∂Xi/∂M=0 No effect  Any change in income does not affect the consumer’s consumption decisionVertical or horizontal ICC
Comparative Statics of Consumer Behavior/Effect of Change in Price of the Product

For the detailed explanation of the income effect with the necessary graphs, please click here.

Effect of Change in Price of Goods in the Equilibrium Position

If the price of the commodity changes other things remaining the same, it affects the consumer’s equilibrium with the swing in budget line and is called price effect. Thus, the price effect shows that the consumer’s choice or equilibrium is being affected by the change in the price of the commodity. The price effect is also different in the case of different goods. the demand for normal goods is inversely affected by the change in the price of a commodity. It has a positive effect in the case of the Giffen good. There is no effect of change in price in the demand for neutral goods.

The following table shows a summary of the price effect in the case of different goods.

Types of GoodsPrice EffectInterpretationNature of PCC Curve
Normal Good∂Xi/∂Px<0 Negative EffectChange in price negatively effect on the consumption of goodDownward sloping PCC in case of normal substitute goods
Giffen Good∂Xi/∂ Px >0 Positive Effect  Change in price positively effect on the consumption of goodBackward or downward bending ICC
Neutral Good∂Xi/∂ Px =0 No effect  Any change in price does not affect the consumer’s demand.Vertical or horizontal PCC
Comparative Statics of Consumer Behavior/Effect of Change in Income of the Product

For the detailed explanation of the income effect with the necessary graphs, please click here.

Income and Substitution Effects

The analysis of the effect of change in prices on the consumer’s demand or consumer’s optimal choice further can be divided into income and substitution effect. Thus, here we investigate the effect of a change in the price of one good in more detail to look at the more accurate and definite predictions.       

For the detailed explanation of the decomposition of price effect into income and substitution click here.

Conclusion

Comparative statics of consumer behavior is related to the study of change in quantities purchased resulting from changes in price or money income of the consumer. The effect of change in the price of the goods and change in income on the consumer’s optimal choice is known as price and income effect respectively. The change in such exogenous variable lead to changes in equilibrium quantities of goods demanded by the consumer. The set of optimal bundles resulted from the change in price is traced by the price consumption curve. Similarly, the income consumption curve traces the set of optimum choices of consumers due to change income while prices remain the same. The comparative study of change in optimal choices of commodities (consumer’s equilibrium points) due to change in exogenous variables is a comparative study of consumer behavior.  

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