A consumer consumes only two goods X and Y and is in equilibrium.,price of X falls..Explain the reaction of the consumer through utility analysis.??
Good attempt by all the students but slightly missed the target. Although the answer provided by Kriti Arora is correct. However, the portion wherein she has stated about the change in consumption of good Y is not required as the question is only concerned about the change in consumption of good X.
The below is the correct answer as per the question and in adherence to the stipulated word limit.
A consumer consuming only two commodities X and Y attains equilibrium at that level where,
when the price of good x falls he will consume more of good x and thus less unit of good y because his level of income remains constant
according to utility approach of two commodity model
mux/px = muy/py--(1)
mux = 12
px = 2
py = 4
substituting in (1)
=> 12/2 = 24/4
=> 6 = 6
now as mentioned earlier the px falls (let px = 1)
thefore the mux rises (let mux = 14)
substituting in (1)
14/1 = 24/4
14 = 6
ie mux/px > muy/py
according to the utility approach 2 commodity approach:
MUx/ Px = MUy/Py if the price of x falls then MUx/Px>MUy/Py. thus to reach to the equilibrium level the consumer will decrease the consumption of good-x and increase the consumption of good-y. the consumer will thus move leftwards on the curve to gain equilibrium.
According to the utility approach a consumer attains equilibrium when MUx/Px = MUy/Py. so if the price of good X falls then MUx/Px > MUy/Py. in that case consumer will start consuming more of good X and consequently consmption of good Y will decrease. increase in consumption of good X will lead to decrease in its marginal utility owing to the law of diminishing marginal utility. same will happen to good Y, its marginal utility will increase due to decrease in its consumption. this will happen untill MUx/Px = MUy/Py and equilibrium is restored again.