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Lesson 4-Changes in Equilibrium - Grade 12 Wassilael

This lesson discusses the concepts of price effect, income effect, and substitution effect as they relate to changes in equilibrium. The price effect refers to changes in consumption of a good due to a change in price, with income held constant. It has two components - the income effect, which is a change in purchasing power from a price change even with no nominal income change, and the substitution effect, which is the remaining portion of the price effect. Examples are given to illustrate the concepts, showing how changes in prices or income can shift the budget constraint and impact the equilibrium point where the consumer operates.

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Wassila Elaheebux
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22 views

Lesson 4-Changes in Equilibrium - Grade 12 Wassilael

This lesson discusses the concepts of price effect, income effect, and substitution effect as they relate to changes in equilibrium. The price effect refers to changes in consumption of a good due to a change in price, with income held constant. It has two components - the income effect, which is a change in purchasing power from a price change even with no nominal income change, and the substitution effect, which is the remaining portion of the price effect. Examples are given to illustrate the concepts, showing how changes in prices or income can shift the budget constraint and impact the equilibrium point where the consumer operates.

Uploaded by

Wassila Elaheebux
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Lesson 4- Changes in equilibrium- Grade 12 WassilaEl

Lesson 4: Changes in Equilibrium

Price Effect, Income Effect and Substitution Effect

Price Effect refers to a change in the combination of a product as a result of a change in its
price (income constant)

The budget line will change (rotate or shift), hence changing the position of the equilibrium point.

A change in the price of a good (the price effect) can actually bring about 2 effects- an income
effect and a substitution effect

Price Effect = Income Effect + Substitution Effect

P.E= I.E+S.E

Example 1

 Equilibrium point Q
 Disposable Income constant
 Py constant; Px falls, Show the price effect.

Money income, nominal income, PY


constant and a fall in Px increases
real income (purchasing power)
which will make the consumer buy
more of good x and become better
off by shifting on a higher IC

Example 2

 Equilibrium point Q
 Income constant
 Px and Py fall. Show the price effect.

1
Lesson 4- Changes in equilibrium- Grade 12 WassilaEl

Income effect

An income effect refers to a situation where a change in the price of a product brings about a
change in real income. Although there is no change in nominal income, a rise or a fall in the
price will have a real income effect (purchasing power). That is a person will be able to buy
more or less of a product resulting of a change in prices.

Example 1

 Equilibrium Point Q
 Px and Py constant
 Income rises. Show income effect.

The explanation above has two assumptions:

(a) Stated Assumption: Py and Px are constant


(b) Unstated Assumption: both goods are normal goods- reason why increase income result
in increased quantities for both good.

However, income effect may be:

(a) Positive (Normal Good)


(b) Negative (Inferior or Giffen good)

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