UNIT 5 CONSUMER BEHAVIOUR:

ORDINAL APPROACH
Structure
5.0 Objectives
5.1 Introduction
5.2 Ordinal Utility Approach
5.3 Indifference Curve Analysis
5.3.1 Indifference Schedule
5.3.2 Indifference Curve
5.3.3 Indifference Map
5.3.4 Law of Diminishing Marginal Rate of Substitution
5.3.5 Properties of Indifference Curve

5.4 Some Exceptional Shapes of Indifference Curve

5.5 Budget Line
5.6 Shift in Budget Line
5.7 Consumer Equilibrium through Indifference Curve Analysis
5.8 Some Exceptional Shapes of Indifference Curve and Corner Equilibrium
5.9 Price Effect as Combination of Income Effect and Substitution Effect
5.9.1 Income Effect
5.9.2 Substitution Effect
5.9.3 Price Effect

5.10 Measuring Income and Substitution Effects of Price Change

5.11 Derivation of Demand Curve from Indifference Curves
5.12 Let Us Sum Up
5.13 References
5.14 Answers or Hints to Check Your Progress Exercises

5.0 OBJECTIVES
After completion of this unit, you will be able to:
• state ordinal utility approach for measurement of utility;
• use Indifference curve analysis to explain consumer behaviour;
• identify shape of Indifference curve in case of perfect substitutes and
complementary goods;
• explain the concept of Budget line;

*Dr. Vijeta Banwari, Assistant Professor in Economics, Maharaja Surajmal Institute, New Delhi.
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• identify the factors causing shift in Budget line; Consumer Behaviour :
Ordinal Approach
• describe consumer equilibrium through Indifference curve approach;

• decompose price effect into income effect and substitution effect using
Hicksian and Slutsky approach; and
• derive demand curve from Price Consumption curve (PCC).

5.1 INTRODUCTION
In Unit 4, we have learnt the concept of cardinal and ordinal utility in order to
understand the concept of consumer preferences. We also examined consumer
equilibrium through cardinal utility analysis. As discussed in previous unit,
study of consumer behaviour has been a focus point for researchers as well as
business houses. Consumer behaviour directly affects the sales and thus profits
of the companies. In order to understand consumer’s buying pattern, it is also
important to understand how consumer equilibrium is attained. A rational
consumer wants to maximise his satisfaction derived from consumption of
various goods but is subject to his budget constraint. In this unit, we will
examine the concept of consumer equilibrium using ordinal utility approach.

5.2 ORDINAL UTILITY APPROACH

Cardinal Utility approach was criticised for being restrictive in nature. English
economist Edgeworth criticised cardinal approach for its Unrealistic
assumptions. He was of opinion that measurement of utility in quantitative
scale is neither possible nor necessary. This idea gave birth to ordinal
approach. Edgeworth also believed that all consumer behaviour can be
measured in terms of preferences and rankings and can be understood using
Indifference curve approach. Though this approach was originally propounded
by Edgeworth, it became popular because of Vilfred Pareto (1906), Slutsky
(1915) and finally because of RGD Allen and J.R Hicks. However, this
approach is also based on some assumptions.
Assumptions of Ordinal Utility Approach

1) Rationality: The basic assumption is that consumer is a rational being,

i.e., he prefers more to less and tries to maximise his satisfaction.

2) Indifference curve analysis assumes that utility is only ordinally

expressible i.e. utility derived from two goods can be compared, as more,
less, or equal, but not how much more or less.

3) Transitivity: Consumer choices are assumed to be transitive. Transitivity

of choices means that if a consumer prefers A to B and B to C, then he
prefers A to C, or if she treats A>B and B>C, then she also treats A>C.

4) Consistency: Consistency of choice means that if a person prefers A over

B in one period, he/she will not prefer B over A in another period.

5) Non satiety: This assumption means that a consumer prefers a larger

quantity of all the goods over smaller quantities of the same.

6) Diminishing Marginal Rate of Substitution (MRS): MRS is that rate at

which a consumer is willing to substitute one commodity (say X) for 93
Theory of another (say Y) while maintaining the same utility or level of satisfaction
Consumer to the consumer. The concept of diminishing MRS will be discussed in
Behaviour greater detail in next section.

5.3 INDIFFERENCE CURVE ANALYSIS

J.R Hicks used the concept of Indifference curve to analyse consumer
behaviour. A consumer facing choice between large number of bundles of two
goods tries to maximise his satisfaction by choosing a combination which gives
him maximum utility. In the course of decision making, consumer finds out
that goods can be substituted for each other and identifies various combinations
of commodities that give him equal level of satisfaction. When all these
combinations are plotted graphically, it produces a curve called Indifference
curve.

5.3.1 Indifference Schedule

An indifference schedule is a table which represents various combinations of
two goods, which yield equal satisfaction to consumer. Since all the
combinations give equal level of satisfaction, consumer is indifferent between
them.
Table 5.1 presents an imaginary indifference schedule representing the various
combinations of two goods X and Y.
Table 5.1: Indifference schedule of two commodities ‘X’ and ‘Y’

Combinations Units of ‘X’ Goods Units of ‘Y’ Satisfaction

(Cup of Tea) Goods (Biscuits)
A 1+ 12 K
B 2+ 8 K
C 3+ 5 K
D 4+ 3 K
E 5+ 2 K

In above table, five different combinations of Tea and Biscuits are depicted.
All these combinations give equal level of satisfaction i.e. K. The consumer is
indifferent whether he buys 1 cup of tea and 12 biscuits or 2 cups of tea and 8
biscuits. Different schedules can be formed showing different levels of
satisfaction.

5.3.2 Indifference Curve

The graphical presentation of Indifference schedule is known as Indifference
curve. The indifference curve is locus of all the combinations of two
commodities which give same level of satisfaction to the consumer.
Fig. 5.1 is graphical representation of Table 5.1. It shows all the combinations
of good X and good Y i.e. A, B, C, D and E which yield equal level of
satisfaction to the consumer. The curve is downward sloping, convex to the
point of origin.

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 Consumer Behaviour :
Ordinal Approach

Fig. 5.1: Indifference curve

5.3.3 Indifference Map

The combinations of two commodities X and Y given in the Indifference
schedule are not the only possible combinations for these commodities. The
consumer may make any other combinations with less of one or both of the
goods, each yielding the same level of satisfaction but less than the one shown
in schedule. IC curve of this schedule will be above IC1. Similarly, the
consumer may make other combinations with more of one or both of the
goods, each combination yielding the same satisfaction but greater than the
satisfaction indicated.
A diagram showing different indifference curves corresponding to different
indifference schedules of the consumer is indifference map. In other words, a
set or family of indifference curves is an indifference map.

Fig. 5.2: Indifference map

Fig. 5.2 shows four indifference curves: IC1, IC2, IC3 and IC4. All the points on
IC2 will yield higher satisfaction than the points on IC1 and all the points on
IC3 will yield lesser satisfaction than the points on IC4.

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Theory of 5.3.4 Law of Diminishing Marginal Rate of Substitution
Consumer
Behaviour What is Marginal Rate of Substitution?
Marginal rate of substitution may be defined as the rate at which a consumer
will exchange successive units of a commodity for another. In other words,
Marginal rate of substitution is the rate at which, in order to get the additional
units of a commodity, the consumer is willing to sacrifice or give up to get one
additional unit of another commodity.
The Marginal Rate of Substitution can symbolically be represented as under:
MRSxy= ΔY/ΔX
Where MRSxy= Marginal rate of substitution of X for Y
ΔY= Change in ‘Y’ commodity
ΔX= Change in ‘X’ commodity.
Diminishing Marginal rate of Substitution
One of the basic postulates of ordinal utility theory is that Marginal rate of
substitution (MRSxy or MRSyx) decreases. It means that the quantity of a
commodity that a consumer is willing to sacrifice for an additional unit of
another commodity goes on decreasing. Law of diminishing Marginal rate of
substitution is an extensive form of the law of diminishing Marginal Utility. As
discussed in previous section, Law of diminishing marginal Utility states that
as a consumer increases the consumption of a good, his marginal utility goes
on diminishing. Similarly as consumer gets more and more unit of good X, he
is willing to sacrifice less and less units of good Y for each extra unit of X. The
significance of good X in terms of good Y goes on diminishing with each
addition of good X. The law can be understood with the help of following
Table 5.2.
Table 5.2: Marginal rate of Substitution

Units of ‘X’ Units of ‘Y’ MRS of ‘X’ for

Good Good ‘Y’
1 10 -
2 7 3:1
3 5 2:1
4 4 1:1

To have the second combination and yet to be at the same level of satisfaction,
the consumer is ready to forgo 3 units of Y for obtaining an extra unit of X.
The marginal rate of substitution of X for Y is 3:1. The rate of substitution is
units of Y for which one unit of X is a substitute. As the consumer desires to
have additional unit of X, he is willing to give away less and less units of Y so
that the marginal rate of substitution falls from 3:1 to 1:1 in the fourth
combination.
In Fig. 5.3 given below at point M on the Indifference curve I, the consumer is
willing to give up 3 units of Y to get an additional unit of X. Hence, MRSxy =3.
As he moves along the curve from M to N, MRSxy, = 2. When the consumer
96 moves downwards along the indifference curve, he acquires more of X and less
of Y. The amount of Y he is prepared to give up to get additional units of X Consumer Behaviour :
becomes smaller and smaller. Ordinal Approach

Fig. 5.3: Indifference curve and Marginal rate of Substitution

The marginal rate of substitution of X for Y (MRSxy) is, in fact, the slope of the
curve at a point on the indifference curve, such as points M, N or P in Fig. 5.3.
Thus MRSxy = ∆Y/∆X

5.3.5 Properties of Indifference Curve

1) Indifference curve slopes downwards from left to right: It implies that
Indifference curve has a negative slope. This attribute is based on the
assumption that if a consumer uses more quantity of one good, he has to
reduce the consumption of the other good in order to stay at the same
level of satisfaction.
2) Indifference curves are generally convex to the origin ‘O’: This
property is based on the principle of Diminishing Marginal Rate of
Substitution. It means that as the units of ‘X’ are increased by equal
amounts, the ‘Y’ diminishes by smaller and smaller amounts. This
happens because as a consumer gets more and more units of ‘X’ good, he
is willing to give up less and less units of good Y for each extra unit of X.
3) Indifference curves cannot intersect each other: This is because of the
fact that each indifference curve represents different level of satisfaction.
If two indifference curves intersect, it will lead to self-contradictory
result. In Fig. 5.4, two Indifference curve IC1 and IC2 are shown
intersecting each other at point C. But this is not possible.
Point ‘A’ and point ‘C’ on Indifference curve IC1 represents combination
yielding equal satisfaction. That is satisfaction from A combination = the
satisfaction from C combination, therefore,
i) Pt. A = Pt. C ( Because both lie on same IC curve IC1)
ii) Pt. B = Pt. C ( Because both lie on same IC curve IC2)
Thus Pt. B = Pt. A in terms of satisfaction. But this is impossible because at
combination ‘B’ quantities of both X and Y are more than in combination ‘A’,
hence this is self-contradictory.

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Theory of
Consumer
Behaviour

Fig. 5.4: Two Indifference curves cannot intersect

Thus, two Indifference curves cannot intersect with each other. The
Indifference curves cannot be tangent to each other.
4) Higher Indifference curve represents higher level of satisfaction: In
Fig. 5.5, the indifference curve IC2 lies above and to the right of the IC1.
Point C on IC2 represents more units of ‘x’ than point A on IC1.
Similarly, Point B on IC2 represents more units of ‘y’ than point A on
IC1. It is thus evident that higher the indifference curve, the higher the
satisfaction it represents because our consumer prefers more of a good to
less of it. Also note that all the points between B and C on IC2 show
larger amounts of both X and Y compared to point A on IC1.

Fig. 5.5: Higher Indifference curve means higher level of satisfaction

5) Indifference curves do not touch either of the axes X or Y . This is

because of the assumption that the consumer purchases combination of
different commodities. In case, an indifference curve touches either axis,
it means the consumer wants only one commodity and his demand for the
98 second commodity is zero. Purchasing one commodity means
 monomania, i.e. consumer’s lack of interest in the other commodity. This Consumer Behaviour :
is against the assumption of Indifference curve which is a two good Ordinal Approach
model.
6) No Indifference curve cuts either of axes: If it were to happen, the
consumer will be consuming negative quantity of that commodity which
makes no sense.

5.4 SOME EXCEPTIONAL SHAPES OF

INDIFFERENCE CURVE
Indifference curve may take a different shape in case of perfect substitutes and
perfect complements. Some exceptional shapes of Indifference curve are
discussed as follows:
Perfect Substitutes
We have examined the concept of perfect substitutes in previous units. Two
goods are perfect substitutes if the utility consumers get from one good is the
same as another.
When two goods are perfect substitutes of each other, their indifference curve
will be a straight diagonal line sloping downwards from left to right. It is
because of the fact that MRS in such cases is constant i.e. 1.
For example: Suppose good A and good B are perfect substitutes, consumer
will be indifferent between them and will be ready to sacrifice equal quantity
of good A to achieve good B. But, even here, the ICs will not cross the axes.

Fig. 5.6: Indifference curve in case of Perfect Substitutes

Perfect Complements
Two goods may be perfect complementary to each other. Just as left and right
shoes, cups and saucers of a tea set etc. In such case, the indifference curve
will be parallel to each other and bent at 90 degree angle or L shaped. Perfect
complementary goods are those goods which are used in fixed ratio i.e. 1:1or
2:2. They cannot be substituted for each other, thus putting MRS as zero. This
99
Theory of case is shown in Fig. 5.7. It is clear that IC1 and IC2 are right angled curves,
Consumer meaning thereby that the consumer buys piece of each right shoe. This will be
Behaviour useless. The consumer will be no better off and he will remain at point ‘A’ on
IC1. In case, he buys 2 pieces of left shoe and only one piece of right shoe, it
will be useless, the consumer will be no better off and he will remain at point C
of IC1. It means that having one more pair of shoe will not add to his
satisfaction. But if he buys one more shoe, his satisfaction will immensely
increase and he will move to point B on higher Indifference curve IC2.

IC3
IC2

IC1

Fig. 5.7: Indifference curve in case of Perfect Complements

Check Your Progress 1
1) Suppose that goods A and B are perfect compliments. Draw a set of
indifference curves for perfect compliments, and explain why the curves
look the way they do. Do the same for perfect substitutes?
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2) Explain the concept of Marginal Rate of Substitution (MRS). What
happens to MRS when consumer moves downward along the
Indifference curve?
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3) Why is Indifference curve convex to origin?
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5.5 BUDGET LINE

As discussed above, a rational consumer always acts according to his budget
constraint and tries to maximise his level of satisfaction. Thus, the knowledge
of the concept of budget line or what is also called budget constraint is
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essential for understanding the theory of consumer’s equilibrium.
A consumer in his attempt to maximise his satisfaction will try to reach the Consumer Behaviour :
highest possible indifference curve. But in his pursuit of maximising Ordinal Approach
satisfaction by buying more and more goods, he has to consider two
constraints: first, he has to pay the prices for the goods and, secondly, he has a
limited money income to purchase the goods. Thus, how much a person is
capable to buy, depends upon the prices of the goods and the money income
which he has at his disposal.
Price line or budget line represents all possible combinations of two goods that
a consumer can purchase with his given income and the given prices of two
goods. Let us try to understand the concept with the help of an example:
Suppose a consumer has an income of Rs. 100 to spend on Oranges and Apples
which cost Rs. 10 each. He can either spend his limited income only on one
good or both the goods. All the possible alternative combinations of two goods
are presented in Table 5.3.
Table 5.3: Alternative consumption possibilities

Income Apples (Rs. 10/piece) Oranges (Rs. 10/piece)

Rs. 100 10 0
Rs. 100 9 1
Rs. 100 8 2
Rs. 100 7 3
Rs. 100 6 4
Rs. 100 5 5
Rs. 100 4 6
Rs. 100 3 7
Rs. 100 2 8
Rs. 100 1 9
Rs. 100 0 10

It can be observed from the above table that if the consumer spends his total
income of Rs. 100 on Apples, he is able to buy 10 Apples. On the other hand, if
he buys Oranges alone, he can get 10 Oranges by spending his total income.
Further, a consumer can also buy both the goods in different combinations.
The budget line can be written algebraically as follows:
Algebraic Expression for Budget Set: The consumer can buy any bundle (A,
B), such that:
M ≥ (PX * QX) + (PY * QY)
Where PX and PY denote prices of goods X and Y respectively and M stands
for money income
We can rewrite the budget line as: PYQY = M – PXQX
• ••
dividing both sides by PY yields: QY = • − ••
Q
•

This is the budget line plotted in Fig. 5.8.

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Theory of SLOPE OF BUDGET LINE
Consumer
Behaviour As we know that the slope of a curve is calculated as a change in variable on
the Y-axis divided by change in variable on the X-axis, slope of the budget line
in given example will be number of units of Oranges, that the consumer is
willing to sacrifice for an additional unit of Apple.
Slope of Budget Line = Units of Oranges (Y) willing to Sacrifice/ Units of
Apples (X) willing to Gain = ∆Y/∆X
In above example, 1 Apple need to be sacrificed each time to gain 1 Orange.
So, Slope of Budget Line = –1/1 = –1
This slope of budget line is equal to ‘Price Ratio’ of two goods.
Price Ratio = Price of X (PX)/Price of Y (PY) = –PX /PY
Budget line is presented in Fig. 5.8.

Fig. 5.8: Budget Line

5.6 SHIFT IN BUDGET LINE

Budget line is drawn on the basis of assumption of constant prices of the goods
and constant income of the consumer. Thus, if there is any change in either of
the two variables, budget line shifts.
Thus, there are two variables that causes shift in Budget Line:
1) Change in Income of the consumer
2) Change in equal proportion of Prices of both the goods.
Change in Income of the consumer
If income changes while the prices of goods remain the same, Budget line will
shift rightwards or leftwards. Since the prices of two goods are constant, slope
102
of budget line will remain constant. The effect of changes in income on the Consumer Behaviour :
budget line is shown in Fig. 5.9. If consumer’s income increases while prices Ordinal Approach
of both goods X and Y remain unaltered, the price line shifts upward and is
parallel to the original budget line.

Fig. 5.9: Effect of change in Income on Budget Line

This is because with the increased income the consumer is able to purchase
proportionately larger quantity of both goods than before.
On the other hand, if income of the consumer decreases, prices of both goods
X and Y remaining unchanged, the budget line shifts downward but remains
parallel to the original price line. This is because a lower income will leave the
consumer in a position to buy proportionately smaller quantities of both goods.
Changes in Price of either of the two goods:
Budget Line also shifts when there is change in price of either of the two
goods. Increase in price of any commodity reduces the purchasing power of the
consumer, in turn reducing the quantity demanded. Shift of Budget line due to
change in prices of either good x or good y is presented below:
Changes in Budget Line as a Result of Changes in Price of Good X
Suppose, price of good X rises, the price of good Y and income remaining
unaltered. With higher price of good X, the consumer can purchase smaller
quantity of X.
In Fig. 5.10, original price line is AB. With increase in Price of good X, budget
line will shift to AB2 i.e. consumer will be able to buy less quantity of good X,
quantity of good Y remaining same. Similarly when there is fall in price of
good X, keeping prices of good Y constant, budget line shifts from AB to AB1
i.e. consumer will be able to buy more quantity of good X, quantity of good Y
remaining same.

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Theory of
Consumer
Behaviour

Fig. 5.10: Shift in Budget line due to change in price of good X

Change in Price of good Y
Fig. 5.11 shows the changes in the budget line when price of good Y falls or
rises, with the price of X and income remaining the same. It can be observed
from Fig. 5.11 that the initial budget line is AB. With fall in price of good Y,
other things remaining unchanged, the consumer could buy more of Y with the
given money income and therefore budget line will shift above to EB.
Similarly, with the rise in price of Y, other things being constant, and the
budget line will shift below to DB.

Fig. 5.11: Shift in Budget line due to change in price of good Y

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Check Your Progress 2 Consumer Behaviour :
Ordinal Approach
1) What is budget line? Calculate slope of Budget line if prices of good X
and good Y are 8 and 10 respectively?
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2) What will happen to budget line if:
Case A: Price of good X increases
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Case B: Price of good Y decreases
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Case C: Income of consumer increases
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5.7 CONSUMER EQUILIBRIUM THROUGH

INDIFFERENCE CURVE ANALYSIS
Assumptions
As discussed above, consumer equilibrium is a point of maximum satisfaction
for the consumer. It is a state of rest for the consumer. Study of Consumer
equilibrium requires some assumptions to be made about the consumer
behaviour. These are:
i) Rationality: The consumer is rational. He wants to obtain maximum
satisfaction given his income and prices.
ii) Consumer has an indifference map, showing his scale of preference for
various combinations of good x and y.
iii) Utility is ordinal: It is assumed that the consumer can rank his preference
according to the satisfaction of each combination of goods.
iv) Consistency of choice: It is also assumed that the consumer is consistent
in the choice of combination of goods.
v) Consumer has a given and fixed amount of money income to spend on
the goods. Thus, consumer has to choose to spend his income on either of
the two goods or a combination thereof.
vi) All the units of the goods are homogeneous.
vii) The goods are divisible i.e. they can be divided into small units.
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Theory of viii) Total utility: The total utility of the consumer depends on the quantities
Consumer of the good consumed.
Behaviour
Conditions of Consumer’s Equilibrium
There are two fundamental conditions of consumer’s equilibrium through
Indifference curve approach:
1) The price line should be tangent to the Indifference curve. It means that at
the point of equilibrium the slope of the indifference curve and of the
price line should be same. The slope of Indifference curve indicates
MRSxy i.e. –ΔY/ΔX. The slope of the price line indicates the ratio
between price of two goods X and Y i.e. Px/Py.
2) Indifference curve should be convex to the point of origin: Marginal rate
of substitution of X for Y (MRSxy i.e. Δy/Δx) is equal to the slope of the
price line that indicates the ratio between prices of two goods.
Condition 1: MRSXY = Ratio of prices or PX/PY
Let the two goods be X and Y. The first condition for consumer’s equilibrium
is that
MRSxy = Px/Py
• If MRSxy> Px/Py, it means that the consumer is willing to pay more for X
than the price prevailing in the market. As a result, the consumer buys
more of X. As a result, MRS falls till it becomes equal to the ratio of
prices and the equilibrium is established.

• If MRSxy< Px/Py, it means that the consumer is willing to pay less for X
than the price prevailing in the market. It induces the consumer to buys
less of X and more of Y. As a result, MRS rises till it becomes equal to
the ratio of prices and the equilibrium is established.

Condition 2: MRS continuously falls

The second condition for consumer’s equilibrium is that MRS must be
diminishing at the point of equilibrium, i.e. the indifference curve must be
convex to the origin at the point of equilibrium. Unless MRS continuously
falls, the equilibrium cannot be established.
Thus, both the conditions need to be fulfilled for a consumer to be in
equilibrium.
Let us now understand this with the help of a diagram:
In Fig. 5.12, IC1, IC2 and IC3 are the three indifference curves and MM is the
budget line. With the constraint of budget line, the highest indifference curve,
which a consumer can reach, is IC2. The budget line is tangent to indifference
curve IC2 at point ‘P’. This is the point of consumer equilibrium.

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 Consumer Behaviour :
Ordinal Approach

Fig. 5.12: Consumer equilibrium through indifference curve

All other points on the budget line to the left or right of point ‘P’ will lie on
lower indifference curves and thus indicate a lower level of satisfaction. As
budget line can be tangent to one and only one indifference curve, consumer
maximises his satisfaction at point P, when both the conditions of consumer’s
equilibrium are satisfied:
i) MRS = Ratio of prices or PX/PY:
At tangency point P, the absolute value of the slope of the indifference curve
(MRS between X and Y) and that of the budget line (price ratio) are same.
Equilibrium cannot be established at any other point such as MRSXY> PX/PY at
all points to the left of point P or MRSXY< PX/PY at all points to the right of
point P. So, equilibrium is established at point P, when MRSXY = PX/PY.
ii) MRS continuously falls:
The second condition is also satisfied at point P as MRS is diminishing at point
P, i.e. IC2 is convex to the origin at point P.

5.8 SOME EXCEPTIONAL SHAPES OF

INDIFFERENCE CURVE AND CORNER
EQUILIBRIUM
As hinted earlier, indifference curve may take different shape in exceptional
cases like perfect complements, perfect substitutes. Also if an assumption of
‘two goods’ is dropped, indifference curve may touch X axis or Y axis also. In
case of an exceptional shape of an indifference curve, equilibrium may be
called as corner solution. This section deals with such cases.
Normally, an equilibrium is achieved at the point of tangency between the
budget line and his indifference curve. At this point, consumer’s preferences
are such that he likes to consume some amount of both the goods. This
equilibrium position at the point of tangency which lies within commodity
space between the two axes is often called interior solution. Interior solution
implies that consumers’ pattern of consumption is diversified and they prefer
basket or bundle of several different goods instead of spending their entire
income on a single commodity.
107
Theory of However, this may not be true in real life scenario and a customer may prefer
Consumer small number of goods and service rather than buying all goods and services
Behaviour available. There may be various reasons for such behaviour – price, taste and
preference etc.
Corner solution when only Commodity Y is purchased
Fig. 5.13 presents a case where indifference map between two goods X and Y
and budget line BL are such that the interior solution is not possible and
consumer in its equilibrium position at point B will not consume any quantity
of commodity X. The reason behind such indifference map is high price of
commodity X. As we already know that the slope of budget line is ratio of
price of two goods, high price of good X makes the budget curve is steeper
than the indifference curves between the two commodities i.e. price or
opportunity cost of commodity X in the market is greater than the marginal rate
of substitution of X for Y which indicates willingness to pay for the
commodity X (Px/Py >MRSxy). The price of good X is so high that the
consumer does not purchase even one unit of the commodity X. Thus the
consumer maximises his satisfaction or is in equilibrium at the corner point B
where he buys only commodity Y. Thus, consumer’s equilibrium in this case is
a corner solution.

Fig. 5.13: Corner solution when only Commodity Y is bought

Corner solution when only Commodity X is purchased
On the other hand, when the indifference map between the two goods is such
that the budget line BL is less steep than the indifference curves between the
two goods so that the MRSxy > Px/Py for all levels of consumption along the
budget line BL. Therefore, he maximises his satisfaction at the corner point L
where he buys only commodity X and none of Y. In this case price of
commodity Y and willingness to pay (i.e. MRS) for it are low that he does not
consider it worthwhile to purchase even one unit of it. Fig. 5.14 presents the
corner solution when only commodity X is purchased.

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 Consumer Behaviour :
Ordinal Approach

Fig. 5.14: Corner solution when only Commodity X is purchased

Corner Equilibrium and Concave Indifference Curves:
The indifference curves are usually convex to the origin. Convexity of
indifference curves is due to the reason that marginal rate of substitution of X
for Y falls as more of X is substituted for Y. However, indifference curves are
concave to the origin in some exceptional cases. Concavity of the indifference
curves implies that the marginal rate of substitution of X for Y increases when
more of X is substituted for Y. Thus, in case of concave indifference curve,
consumer will choose or buy only one good. It implies that the customer
prefers to buy only one good and does not prefer diversification in his buying
pattern.
In case of concave indifference curves, the consumer will not be in equilibrium
at the point of tangency between budget line and indifference curve, that is, in
this case interior solution will not exist. Instead, we would have corner solution
for consumer’s equilibrium. Corner solution in case of concave indifference
curve is presented in Fig. 5.15.

Fig. 5.15: Consumer equilibrium in case of concave indifference curves

It can be observed from Fig. 5.15 that the given budget line BL is tangent to
the indifference curve IC2 at point Q. However, consumer cannot be in
equilibrium at Q since by moving along the given budget line BL he can get on
109
Theory of to higher indifference curves and obtain greater satisfaction than at Q. Thus, by
Consumer moving on higher indifference curve he will reach at extreme point B or point
Behaviour L. In Fig. 5.15, point B is on higher indifference curve. Thus, consumer will be
satisfied at point B where he will buy OB units of commodity Y. It should be
noted that at B the budget line is not tangent to the indifference curve IC5, even
though the consumer is here in equilibrium. It is clear that when a consumer
has concave indifference curves, he will consume only one good.
Corner solution in case of Perfect Substitutes and Perfect Complements:
Another case of corner solution to the consumer’s equilibrium occurs in case of
perfect substitutes. As seen above, indifference curves for perfect substitutes
are linear. In their case tangency or interior solution for consumer’s
equilibrium is not possible since the budget line cannot be tangent to a point of
the straight-line indifference curve of substitutes.
In this case budget line would cut the straight-line indifference curves. Fig.
5.16A presents a case where slope of the budget line BL is greater than the
slope of indifference curves. If the slope of the budget line is greater than the
slope of indifference curves, B would lie on a higher indifference curve than L
and the consumer will buy only Y.

Fig. 5.16 A: Corner equilibrium in case of Perfect Substitutes

Fig. 5.16 B presents a case the slope of the budget line can be less than the
slope of indifference curve. If the slope of the budget line is less than the slope
of indifference curves, L would lie on a higher indifference curve than B and
the consumer will buy only X.

Fig. 5.16 B: Corner equilibrium in case of Perfect Substitutes

Perfect complements
Another exceptional case of perfect complementary goods is presented in Fig.
110 5.17. Indifference curves of perfect complementary goods have a right-angled
shape. In such a case the equilibrium of the consumer will be determined at the Consumer Behaviour :
corner of indifference curve which just touches the budget line. It can be noted Ordinal Approach
from Fig. 5.17 that in case of perfect complements equilibrium point will be
point C and will be consuming OM of X and ON of Y.

Fig. 5.17: Corner solution in case of Perfect Complements

5.9 PRICE EFFECT AS COMBINATION OF

INCOME EFFECT AND SUBSTITUTION
EFFECT
As discussed above, a consumer’s equilibrium position is affected by the
changes in his income, prices of substitute and changes in the price of goods
consumed. These effects are known as:
1) Income effect,
2) Substitution effect, and
3) Price effect

5.9.1 Income Effect

In the analysis of the consumer’s equilibrium it is assumed that the income of
the consumer remains constant, and the prices of the goods X and Y are given.
Thus, given the tastes and preferences of the consumer and the prices of the
two goods, if the income of the consumer changes, the effect it will have on his
purchases is known as the Income effect.
The Income effect may be defined as the effect on the purchases of consumer
caused by the changes in income, if the prices of goods remain constant. If the
income of the consumer increases his budget line will shift upward to the right,
parallel to the original budget line. On the contrary, a fall in his income will
shift the budget line inward to the left. The budget lines are parallel to each
other because relative prices remain unchanged.
Assumptions of Income Effect
1) The prices of both the commodities X and Y remain constant
2) Taste and preferences remain constant
111
Theory of 3) There is no change in fashion and market condition
Consumer
Behaviour Kinds of Income Effect
Income effect may be of three types:
1) Positive Income effect
2) Negative Income effect
3) Zero Income effect
1) Positive Income effect: When an increase in income leads to an increase
in demand for a commodity or for both the commodities the income
effect is positive. In case of Normal goods, income effect is positive and
Income consumption curve slopes upwards to the right.
2) Negative Income effect: Income effect is negative, when with the
increase in his income, the consumer reduces his consumption of the
good. Income effect is negative in case of inferior goods.
3) Zero Income effect: If with the change in income, there is no change in
the quantity purchased of a commodity, than the income effect is said to
be zero. Zero income effect is in case of goods like medicines, necessities
like salt etc.
All the three effects are explained diagrammatically.
In Fig. 5.18, when the budget line is B1, the equilibrium point is X* where it
touches the indifference curve I1. If now the income of the consumer increases,
B1 will move to the right as the budget line B2, I1, and the new equilibrium
point is X1 where it touches the indifference curve I2. As income increases
further, B3 becomes the budget line with X2 as its equilibrium point.
The locus of these equilibrium points X*, X1 and X2 traces out a curve which is
called the income-consumption curve (ICC). The ICC curve shows the income
effect of changes in consumer’s income on the purchases of the two goods,
given their relative prices.
Normally, when the income of the consumer increases, he purchases larger
quantities of two goods. Usually, the income consumption curve slopes
upwards to the right as shown in Fig. 5.18. Here the income effect is also
positive and both X and Y are normal goods.

Fig. 5.18: Income Consumption curve-Normal goods

112
But an Income-consumption curve can have any shape provided it does not Consumer Behaviour :
intersect an Indifference curve more than once. Ordinal Approach

The second type of ICC curve may have a positive slope in the beginning but
become and stay horizontal beyond a certain point when the income of the
consumer continues to increase. In case where X is a superior good and Y is a
necessity, shape of ICC curve will be as shown in Fig. 5.19.
In Fig. 5.19, the ICC curve slopes upwards with the increase in income up to
the equilibrium point R at the budget line P1Q1 on the indifference cure I2.
Beyond this point it becomes horizontal which means that the consumer has
reached the saturation point regarding consumption of good Y. He buys the
same amount of Y (RA) as before despite further increases in his income. It
often happens in the case of a necessity (like salt) whose demand remains the
same even when the income of the consumer continues to increase further.
Here Y is a necessity.

Fig. 5.19: Income Consumption curve (X is a superior good and Y is a necessity)

Further, the demand of inferior goods falls, when the income of the consumer
increases beyond a certain level, and he replaces them by superior substitutes.
For example, he may replace coarse grains by wheat or rice, and coarse cloth
by a fine variety. In Fig. 5.20, good X is inferior and Y is a normal good.
It can be observed from the Fig. 5.20, that up to point R the ICC curve has a
positive slope and beyond that it is negatively inclined. The consumer’s
purchases of X fall with the increase in his income.

Fig. 5.20: Income Consumption curve (Y is normal good and X is inferior)

113
Theory of The different types of income-consumption curves are also shown in Fig. 5.21
Consumer where: (1) ICC1, has a positive slope and relates to normal goods; (2) IСС2 is
Behaviour horizontal from point A, X is a normal good while Y is a necessity of which
the consumer does not want to have more than the usual quantity as his income
increases further: (3) IСС3 is vertical from A, y is a normal good here and X is
satiated necessity; (4) ICC4 is negatively inclined downwards, Y becomes an
inferior good form A onwards and X is a superior good; and (5) ICC5 shows X
as an inferior good.

Fig. 5.21: Possible shapes of Income Consumption curve (ICC)

5.9.2 Substitution Effect

The substitution effect relates to the change in the quantity demanded resulting
from a change in the price of one good it prompts the substitution of relatively
cheaper good for a dearer one, while keeping the price of the other good, real
income and tastes of the consumer as constant. Prof. Hicks has explained the
substitution effect independent of the income effect through compensating
variation in income. “The substitution effect is the increase in the quantity
bought as the price of a commodity falls, after adjusting income so as to keep
the real purchasing power of the consumer the same as before. This adjustment
in income is called compensating variations and is shown graphically by a
parallel shift of the new budget line until it become tangent to the initial
indifference curve.”
Thus, on the basis of the methods of compensating variation, the substitution
effect measures the effect of change in the relative price of a good. The
increase in the real income of the consumer as a result of fall in the price of,
say good X, is so withdrawn that he is neither better off nor worse off than
before.
The substitution effect is explained in Fig. 5.22 where the original budget line
is PQ with equilibrium at point R on the indifference curve I1. At R, the
consumer is buying OB of X and BR of Y. Suppose the price of X falls so that
his new budget line is PQ1. With the fall in the price of X, the real income of
the consumer increases. To make the compensating variation in income or to
keep the consumer’s real income constant, take away the increase in his
income equal to PM of good Y or Q1N of good X so that his budget line
PQ1 shifts to the left as MN and is parallel to it so that new budget line tangent
to I1 at point H.
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 Consumer Behaviour :
Ordinal Approach

Fig. 5.22: Substitution effect (Hicksian Analysis)

As MN is tangent to the original indifference curve I1, at point H, the consumer

buys OD of X and DH of Y. Thus PM of Y or Q1N of X represents the
compensating variation in income, as shown by the line MN being tangent to
the curve I1 at point H. Now the consumer substitutes X for Y and moves from
point R to H or the horizontal distance from В to D. This movement is called
the substitution effect. The substitution affect is always negative because when
the price of a good falls (or rises), more (or less) of it would be purchased, the
real income of the consumer and price of the other good remaining constant. In
other words, the relation between price and quantity demanded being inverse,
the substitution effect is negative.

5.9.3 Price Effect

The price effect indicates the way the consumer’s purchases of good X change,
when its price changes, given his income, tastes and preferences and the price
of good Y. This is shown in Fig. 5.23. Suppose the price of X falls. The budget
line PQ will extend further out to the right as PQ1, showing that the consumer
will buy more X than before as X has become cheaper. The budget line
PQ2 shows a further fall in the price of X. Any rise in the price of X will be
represented by the budget line being drawn inward to the left of the original
budget line towards the origin.
If we regard PQ2, as the original budget line, a two time rise in the price of X
will lead to the shifting of the budget line to PQ1, and PQ2 – PQ. Each of the
budget lines fanning out from P is a tangent to an indifference curve I1, I2, and
I3 at R, S and T respectively. The curve PCC connecting the locus of these
equilibrium points is called the price-consumption curve (PCC). The price-
consumption curve indicates the price effect of a change in the price of X on
the consumer’s purchases of the two goods X and Y, given his income, tastes,
preferences and the price of good Y.

115
Theory of
Consumer
Behaviour

Fig. 5.23: Price effect through Indifference curve analysis

Check Your Progress 3

1) Differentiate between Income effect, price effect and substitution effect.
......................................................................................................................
......................................................................................................................
......................................................................................................................
2) What will be the shape of Income consumption curve (ICC):
Case A: X is an inferior good, Y is superior good
......................................................................................................................
......................................................................................................................
Case B: Y is an inferior good, X is superior good
......................................................................................................................
......................................................................................................................

5.10 MEASURING INCOME AND SUBSTITUTION

EFFECTS OF PRICE CHANGE
As noted above, the change in consumption basket due to change in the prices
of consumer goods is called price effect. Price effects combines two effects:
Income effect and substitution effect. Income effect is the result of increase in
real income due to decrease in price of a commodity. Substitution effect arises
due to substitution of costly good by cheaper good. This section presents the
decomposition of Income and substitution effect from the price effect. There
are two approaches for the decomposition: a) Hicksian approach, and b)
Slutsky approach.
Hicksian approach uses two methods of splitting the price effect, namely
i) Compensating variation in income

116 ii) Equivalent variation in income.

Slutsky uses cost-difference method to decompose price effect into its two Consumer Behaviour :
component parts. Ordinal Approach

Hicksian or Compensating Variation approach

In this method of decomposition of price effect into income and substitution
effects by compensating variation, income of the consumer is adjusted so as to
offset the change in satisfaction and bring the consumer back to his original
indifference curve, that is, his initial level of satisfaction before the change in
price.
For instance, with the fall in price of a commodity, a consumer moves to a new
equilibrium position at a higher indifference curve i.e. at a higher level of
satisfaction. To offset this increase in satisfaction resulting from a fall in price
of the good, one part of income is taken back to force him to come back at his
original indifference curve. This requires reduction in income (say, through
levying a lump sum tax) to cancel out the gain in satisfaction or welfare on
account of by reduction in price of a good. It is called compensating variation
in income.
The effect is called compensating variation in income because it compensates
(in a negative way) for the gain in satisfaction resulting from a price reduction
of the commodity. Process of decomposition of price effect into substitution
effect and income effect through the method of compensating variation in
income is presented in Fig. 5.24.

Fig. 5.24: Decomposition of price effect into income effect and substitution effect through
Compensating variation in Income

It can be observed from Fig. 5.24, that when price of good X falls, budget line
shifts to PL2 i.e. real income of the consumer i.e. he can buy more of both the
goods with his increased income. With the new budget line PL2, consumer is in
equilibrium at point R on a higher indifference curve IC2 and enjoy increased
satisfaction as a result of fall in price of good X.
Suppose, money income of the consumer is reduced by the compensating
variation in income so that he is forced to come back to the original
indifference curve IC1 he would buy more of X since X has now become
117
Theory of relatively cheaper than before. In Fig. 5.24, with the reduction in income by
Consumer compensating variation, budget line will shift to AB which has been drawn
Behaviour parallel to PL2 so that it just touches the indifference curve IC1 on which he
was before the fall in price of X.
Since the price line AB has got the same slope as PL2, it represents the changed
relative prices with X being relatively cheaper than before. Now, X being
relatively cheaper than before, the consumer, in order to maximise his
satisfaction, in the new price income situation substitutes X for Y.
Thus, when the consumer’s money income is reduced by the compensating
variation in income (which is equal to PA in terms of Y or L2B in terms of X),
the consumer moves along the same indifference curve IC1 and substitutes X
for Y. At price line AB, consumer is in equilibrium at S at indifference curve
IC1 and is buying MK more of X in place of Y. This movement from Q to S on
the same indifference curve IC1 represents the substitution effect since it occurs
due to the change in relative prices alone, real income remaining constant.
If the amount of money income which was taken away from him is now given
back to him, he would move from S at indifference curve IC1 to R on a higher
indifference curve IC2. The movement from S at lower indifference curve to R
on a higher in difference curve is the result of income effect. Thus the
movement from Q to R due to price effect can be regarded as having taken
place into two steps first from Q to S as a result of substitution effect and
second from S to R as a result of income effect. Thus, price effect is the
combined result of a substitution effect and an income effect.
In Fig. 5.24 the various effects on the purchases of good X are:
• Price effect = MN
• Substitution effect = MK
• Income effect = KN
• MN = MK+KN or
Price effect = Substitution effect + Income effect
Slusky’s Cost difference approach
In Slutsky’s approach, when the price of good changes and consumer’s real
income or purchasing power increases, the income of the consumer is changed
by the amount equal to the change in its purchasing power which occurs as a
result of the price change. His purchasing power changes by the amount equal
to the change in the price multiplied by the number of units of the good which
the individual used to buy at the old price.
In other words, in Slutsky’s approach, income is reduced or increased (as the
case may be), by the amount which leaves the consumer to be just able to
purchase the same combination of goods, if he so desires, which he was having
at the old price.
That is, the income is changed by the difference between the cost of the
amount of good X purchased at the old price and the cost of purchasing the
same quantity of X at the new price. Income is then said to be changed by the
cost difference. Thus, in Slutsky substitution effect, income is reduced or
118
increased not by compensating variation as in case of the Hicksian substitution Consumer Behaviour :
effect, but, by the cost difference. Ordinal Approach

Slutsky substitution effect is explained in Fig. 5.25.

Fig. 5.25: Slutsky’s Substitution Effect (For a Fall in Price)

Initially, with a given money income and the given prices of two goods as
represented by the price line PL, the consumer is in equilibrium at point Q on
the indifference curve IC1 where consumer is buying OM units of good X and
ON units of good Y. Suppose that price of X falls, price of Y and money
income of the consumer remaining constant. As a result of this fall in price of
X, the price line will shift to PL' and the real income or the purchasing power
of the consumer will increase.
In order to identify Slutsky’s substitution effect, consumer’s money income
must be reduced by the cost difference or, in other words, by the amount which
will leave him to be just able to purchase the old combination Q, if he so
desires.
For this, a price line GH parallel to PL' has been drawn which passes through
the point Q. It means that income equal to PG in terms of Y or LH in terms of
X has been taken away from the consumer and as a result he can buy the
combination Q, if he so desires, since Q also lies on the price line GH.
Consumer will not now buy the combination Q since X has now become
relatively cheaper and Y has become relatively dearer than before. The change
in relative prices will induce the consumer to rearrange his purchases of X and
Y. He will substitute X for Y. But in this Slutsky substitution effect, he will not
move along the same indifference curve IC1, since the price line GH, on which
the consumer has to remain due to the new price-income circumstances is
nowhere tangent to the indifference curve IC1.
The price line GH is tangent to the indifference curve IC2 at point S. Therefore,
the consumer will now be in equilibrium at a point S on a higher indifference
curve IC2. This movement from Q to S represents Slutsky substitution effect
according to which the consumer moves not on the same indifference curve,
but from one indifference curve to another.
It is important to note that movement from Q to S as a result of Slutsky
substitution effect is due to the change in relative prices alone, since the effect
119
Theory of due to the gain in the purchasing power has been eliminated by making a
Consumer reduction in money income equal to the cost-difference.
Behaviour
At S, the consumer is buying OK of X and OW of Y; MK of X has been
substituted for NW of Y. Therefore, Slutsky substitution effect on X is the
increase in its quantity purchased by MK and Slutsky substitution effect on Y
is the decrease in its quantity purchased by NW.

5.11 DERIVATION OF DEMAND CURVE FROM

INDIFFERENCE CURVES
A demand curve shows quantity of a good purchased or demanded at various
prices, assuming that tastes and preferences of a consumer, his income, and
prices of all related goods remain constant. Demand curve showing
relationship between price and quantity demanded can be derived from price
consumption curve (PCC) of indifference curve analysis.
In Marshallian utility analysis, demand curve was derived on the assumptions
that utility was cardinally measurable and marginal utility of money remained
constant with the change in price of the good. In the indifference curve
analysis, demand curve is derived without making such assumptions.
Let us suppose that a consumer has got income of Rs. 300 to spend on goods.
In Fig. 5.26 money is measured on the Y-axis, while the quantity of the good X
whose demand curve is to be derived is measured on the X-axis. An
indifference map of a consumer is drawn along with the various budget lines
showing different prices of the good X. Budget line PL1 shows that price of the
good X is Rs. 15 per unit.
As price of good X falls from Rs. 15 to Rs. 10, the budget line shifts to PL2.
Budget line PL2 shows that price of good X is Rs. 10. With a further fall in
price to Rs. 7.5 the budget line takes the position PL3. Thus PL3 shows that
price of good X is Rs. 7.5. When price of good X falls to Rs. 6, PL4 is the
relevant budget line.
Tangency points between the various budget lines and indifference curves,
which when joined together by a line constitute the price consumption curve
shows the amounts of good X purchased or demanded at various prices. With
the budget line PL1 the consumer is in equilibrium at point Q1 on the price
consumption curve (PCC) at which the budget line PL1 is tangent to
indifference curve IC1. In his equilibrium position at Q1 the consumer is buying
OA units of the good X. In other words, it means that the consumer demands
OA units of good X at price Rs. 15. When price falls to Rs. 10 and thereby the
budget line shifts to PL2, the consumer comes to be in equilibrium at point Q2
the price-consumption curve PCC where the budget line PL2 is tangent to
indifference curve IC2. At Q2, the consumer is buying OB units of good X.
In other words, the consumer demands OB units of the good X at price Rs. 10.
Likewise, with budget lines PL3 and PL4, the consumer is in equilibrium at
points Q3 and Q4 of price consumption curve and is demanding OC units and
OD units of good X at price Rs. 7.5 and Rs. 6 respectively. Thus, price
consumption curve shows the quantity demanded of the good X against various
prices.

120
 Consumer Behaviour :
Ordinal Approach

Money

Fig. 5.26: Derivation of demand curve from indifference curve

In most cases, the demand curve of individuals will slope downward to the
right, because as the price of a good falls both the substitution effect and
income effect pull together in increasing the quantity demanded of the good.
Even when the income effect is negative, the demanded curve will slope
downward to the right if the substitution effect is strong enough to overcome
the negative income effect. Only when the negative income effect is powerful
enough to outweigh the substitution effect can the demand curve slope upward
to the right instead of sloping downward to the left.
Deriving Demand Curve for a Giffen Good:
Giffen good is a good where higher price causes an increase in demand
(reversing the usual law of demand). The increase in demand is due to the
income effect of the higher price outweighing the substitution effect. In this
section we will derive the demand curve of a Giffen good.
In Fig. 5.26, demand curve DD in case of a normal good is downward sloping.
There are two reasons behind downward slope: a) income effect b) substitution
effect.
Both the income effect and substitution effect usually work towards increasing
the quantity demanded of the good when its price falls and this makes the
demand curve slope downward. But in case of Giffen good, the demand curve
slopes upward from left to right. This is because in case of a Giffen good,
income effect, which is negative and works in opposite direction to the
substitution effect, outweighs the substitution effect. This results in the fall in
121
Theory of quantity demanded of the Giffen good when its price falls and therefore the
Consumer demand curve of a Giffen good slopes upward from left to right. Fig. 5.27
Behaviour presents the Indifference curves of a Giffen good along with the various budget
lines showing various prices of the good. Price consumption curve of a Giffen
good slopes backward.

Fig. 5.27: Upward Sloping Demand Curve for a Giffen Good

It is evident from Fig. 5.27 (the upper portion) that with budget line PL1 (or
price P1) the consumer is in equilibrium at Q1 on the price consumption curve
PCC and is purchasing OM) amount of the good. With the fall in price from P1
to P2 and shifting of budget line from PL1 to PL2, the consumer goes to the
equilibrium position Q3 at which he buys OM2 amount of the good. OM2 is less
than OM1.
Thus, with the fall in price from P1 to P2 the quantity demanded of the good
falls. Likewise, the consumer is in equilibrium at Q3 with price line PL3 and is
purchasing OM at price P3. With this information we can draw the demand
curve, as is done in the lower portion of Fig. 5.26. It can be seen from Fig. 5.27
(lower part) that the demand curve of a Giffen good slopes upward to the right
indicating that the quantity demanded varies directly with the changes in price.
With the rise in price, quantity demanded increases and with the fall in price
quantity demanded decreases.
Check Your Progress 4
1) Differentiate between Hicksian or Compensating Variation approach and
Slutsky Cost difference approach.
......................................................................................................................
......................................................................................................................
......................................................................................................................
122
2) How can demand curve be derived from Indifference curve? Consumer Behaviour :
Ordinal Approach
......................................................................................................................
......................................................................................................................
......................................................................................................................

5.12 LET US SUM UP

In this unit, we have learnt consumer equilibrium through Indifference curve
analysis. Consumer equilibrium is a situation, in which a consumer derives
maximum satisfaction, with no intention to change it and subject to given
prices and his given income. In indifference curve analysis, the point of
maximum satisfaction is achieved by studying indifference map and budget
line together. We have discussed the concept of budget line to identify
consumer equilibrium. Price line or budget line represents all possible
combinations of two goods that a consumer can purchase with his given
income and the given prices of two goods. Budget line may shift due to change
in income or change in prices of either of the two commodities. We further
examined the two conditions of consumer equilibrium i.e. MRSXY = Ratio of
prices or PX/PY and continuous fall of MRS. We have also learnt how is Price
effect combination of income effect and substitution effect using Hicksian and
Slutsky’s analysis. Demand curve has been derived from price consumption
curve.

5.13 REFERENCES
1) Dwivedi, D.N.(2008) Managerial Economics, 7th edition, Vikas Publishing
House.
2) Dornbusch, Fischer and Startz, Macroeconomics, McGraw Hill, 11th
edition, 2010.
3) Hal R. Varian, Intermediate Microeconomics, a Modern Approach, 8th
edition, W.W. Norton and Company/Affiliated East-West Press (India),
2010.
4) Kumar, Raj and Gupta, Kuldip (2011) Modern Micro Economics: Analysis
and Applications, UDH Publishing House.
5) Samuelson, P & Nordhaus, W. (1st ed. 2010) Economics, McGraw Hill
education.
6) Salvatore, D. (8th rd. 2014) Managerial Economics in a Global economy,
Oxford University Press.
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123
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20) http://www.economicsdiscussion.net/cardinal-utilitv-analysis/price-
demand-relationship-normal-inferior-and-giffen-goods/1069
21) http://www.vourarticlelibrary.com/economics/the-slutskv-substitution-
effect-explained/36663
22) http://www.economicsdiscussion.net/cardinal-utilitv-analysis/how-to-
derive-individuals-demand-curve-from-indifference-curve-analysis-with-
diagram/1076

5.14 ANSWERS OR HINTS TO CHECK YOUR

PROGRESS EXERCISES
Check Your Progress 1
1) Study Section 5.4 and answer
2) Study Sub-section 5.3.4 and answer
3) Indifference curve is convex to origin because of diminishing marginal
rate of substitution.
Check Your Progress 2
1) Study Section 5.5 and answer
2) Study Section 5.6 and answer
Check Your Progress 3
1) Study Section 5.9 and answer
2) Study Section 5.9 and answer
Check Your Progress 4
1) Study Section 5.10 and answer
2) Study Section 5.11 and answer
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