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PRICE CHANGE, UTILITY ANALYSIS:
A disruption of consumer equilibrium identified with utility analysis caused by changes in the price of a good, which likely results in a change in the quantities of the goods consumed. The change in the price alters the marginal utility-price ratio and forces a reevaluation of the rule of consumer equilibrium. Utility analysis can be used to illustrate how a change in the price of a good alters the consumer equilibrium combination of goods consumed. According to the law of demand, a change in the demand price of one good results in an opposite change in the quantity demanded of that good.
Moreover, according to the other prices demand determinant, a change in the price of one good is also likely to affect the purchase of another good. As such, this particular utility analysis of consumer equilibrium can provide insight into both the law of demand and the other prices demand determinant.
A Review of Consumer Equilibrium
First, a review of consumer equilibrium is in order.
|Pretzels and Sundaes
A Sundae Price ChangeThe main point of analysis is to pose the question: What happens if there is a change in the price of one good? In particular, suppose that the price of hot fudge sundaes declines from $4 to $2. How might the consumer equilibrium purchase of pretzels and hot fudge sundaes change?
To answer this question, the original consumer equilibrium must be reevaluated. If Duncan continues to consume 3 sundaes and 4 pretzels after the sundae price reduction, his total expenditures are only $14 ($6 spent on 3 sundaes and $8 spent on 4 pretzels). In effect, Duncan has an extra $6 of income to spend.
With the lower $2 hot fudge sundae price, Duncan could purchase up to 3 more sundaes. However, in that the pretzel price is also $2, Duncan could purchase up to 3 additional pretzels, too. In fact, because both goods now carry a $2 price, Duncan could purchase any combination of extra pretzels and sundaes that sums up to 3.
The key to determining the extra quantity of each good purchased is the same as that for the initial consumer equilibrium--the marginal utility-price ratio. Because the price of hot fudge sundaes changes, the marginal utility-price ratio for each quantity also changes. To reveal the new ratios, click the [New Ratios] button in the exhibit to the right. Note that for each hot fudge sundae, Duncan now receives a greater level of satisfaction per dollar spent.
|Pretzels and Sundaes
This new set of marginal utility-price ratios reveals that the original purchase of 3 sundaes generates 6 utils per dollar, compared to the initial ratio of 3 utils per dollar. Moreover, this new ratio means the rule of consumer equilibrium is now out of balance. The fourth pretzel generates 3 utils per dollar, but the third sundae generates 6 utils per dollar.
Because Duncan receives a greater amount of satisfaction per dollar spent on sundaes, it seems reasonable for him to purchase more.
The purchase of 5 hot fudge sundaes and 5 pretzels achieves consumer equilibrium, given the new hot fudge sundae price. This combination satisfies the rule of consumer equilibrium and maximizes the utility achieved with his $20 budget. Click the [New Equilibrium] button to highlight this combination.
- Suppose Duncan opts for a fourth sundae. If so, his total expenditure rises to $16, and the marginal utility-price ratio for sundaes falls to 4 utils per dollar. While this moves him closer to consumer equilibrium, the rule of consumer equilibrium remains out of balance. His sundae marginal utility-price ratio (4 utils per dollar) is still greater than his pretzel marginal utility-price ratio (3 utils per dollar).
- A fifth sundae seems to be in order. This purchase raises his total expenditure to $18 and drives the sundae marginal utility-price ratio down to 2 utils per dollar. This ratio, however, is now below the 3 utils per dollar pretzel marginal utility-price ratio.
- What about buying another pretzel? A fifth pretzel does the trick of restoring consumer equilibrium. This purchase raises total expenditure to $20. It also drives the marginal utility-price ratio for pretzels down to 2 utils per dollar, achieving equality with the marginal utility-price ratio for 5 hot fudge sundaes.
Summing UpWhat can be concluded from this analysis?
- Law of Demand: First, consider how the change in the price of hot fudge sundaes affects the quantity of hot fudge sundaes purchased. The price decreases and the quantity increases. This reflects the basic inverse relation between demand price and quantity demanded that is the law of demand.
- Other Prices Demand Determinant: Second, consider a change in the price of hot fudge sundaes affects the quantity of pretzels purchased. The price of sundaes decreases and the quantity of pretzels increases. This particular example suggests a complementary relation between pretzels and sundaes.
PRICE CHANGE, UTILITY ANALYSIS, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: March 3, 2024].
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