CROSS PRICE EFFECT

Cross Price Effect
Effect of change in the price of a good on the demand of its related good is known as cross price effect. 
We know related goods are of two types
(1) Substitute goods, and
(2) Complementary goods
Accordingly we can split out discussion in two parts, 
(1) Demand for a Commodity in relation to Price of the Substitute Good: Let us consider tea and coffee as two substitute goods. Let tea be the commodity demanded of which demand curve is D1. 
(a) Increase in Price of Substitute Good:Initially, if price of tea is OP1, quantity purchased is OT1. Now suppose the price of tea remains constant but the price of coffee increases. 
Reaction of Consumer
As a rational consumer you may decide to ubstitute some tea in place of coffee. Or you are expected to buy more of tea even it's price is constant. Initially you were buying P1K1 quantity of tea. Now you are willing to buy P1K2. Greater purchase of a commodity at its constant price points to a situation of increase in demand, or forward shift in demand curve. Accordingly, demand curve for tea shifts to the right, from D1 to D2. 
(b) Decrease in Price of Substitute Good: If Price of coffee decreases, consumer will tend to substitute some coffee in place of tea. Or will demand less tea even when it's price is constant. 
Initially consumer was buying P1K1 of tea. Now, he is buying P1K2 of tea even when price of tea is constant. This is a situation of backward shift in demand curve. Demand curve shift from D1 to D2. 
(2) Demand for a Commodity in relation to the Price of the Complementary Good:Let us consider car and petrol as complementary goods. Let cars be the commodity demanded of which the demand curve is D1.
(a) Increase in Price of Complementary Good: Initially, if price of cars is OP1, numbers of cars purchased is P1K1. Now, suppose this price remains constant but the price of petrol increases. 
Reaction of Consumer
They would tend to buy less cars, even when price of the cars is constant. 
Now, even when price of cars is constant,  P1K2 cars are purchased, because the price of petrol has increased. This is a situation of decrease in demand or backward shift in demand curve. Accordingly,  demand curve shifts from D1 to D2. 
(b) Decrease in Price of Complementary Good: If price of petrol decreases, people will have the tendency to buy more cars, even when price of cars is constant. This is a situation of increase in demand or forward shift of demand curve.
Initially P1K1 cars are purchased. As price of petrol decreases, P1K2 cars are purchased even when price of cars is constant. Accordingly,  demand curve shift forward from D1 to D2. 

Comments

Post a Comment

If you have any doubt, please let me know.

Popular posts from this blog

CONSUMER'S EQUILIBRIUM (INDIFFERENCE CURVE ANALYSIS)

Image
Indifference Set Indifference set is a set of different combinations of two goods which offers the consumer the same level of satisfaction. Indifference Curve Indifference curve is a curve which shows different combinations offering the same level of satisfaction to the consumer.  Properties Of Indifference Curve(IC)  (1) IC Slopes Downward- IC slopes downward from left to right. It means that IC has a negative slope. It implies if the consumer decides to have more of one good, he must have less of the other.  (2) IC is Convex to the Origin- It means that the slope of IC tends to decline, as we move along the IC from left to right. (3) Higher IC shows Higher Level of Satisfaction- A set of ICs drawn in a graph is known as Indifference map.Each IC in the indifference map corresponds to different level of consumer's income. Higher IC indicates higher level of satisfaction. (4) IC doesn't touch X-axis or Y-axis - This i
Read more

Impact of Tastes and Preferences on Demand for a Commodity

Image
Impact of Tastes and Preferences on Demand for a Commodity Tastes and Preferences of the buyers are determined by three factors,  (1) Individuals Likes and Dislikes: Individuals tend to buy more or less of a commodity simply because their likes and dislikes tend to change.  (2) Trends and Fashions: Most individuals are influenced by the emerging trends and fashions. They simply want to be 'trendy'; accordingly, they prefer to buy more of a commodity which is the latest trend or fashion.  (3) Climatic Environment: The tastes and preferences of consumers tend to change with change in climatic environment. Winter season induces them to goods like, tea and coffee while summer season induces them to goods like, cold drink and ice cream.  Favourable and Unfavourable Change in Tastes and Preferences Favourable change in tastes and preferences induces the buyers to buy more of a commodity even when it's price continues to be the same this is a situation of increase in demand, imply
Read more

CONSUMER'S EQUILIBRIUM(UTILITY ANALYSIS)

Image
CONSUMER'S EQUILIBRIUM (Utility Analysis)  Consumer's equilibrium refers to a situation when a consumer maximises his satisfaction, spending his given income across different goods and services.  Different cases of consumer's equilibrium (1) When only one commodity is consumed (2) When two or more commodities are       consumed.  Consumer's Equilibrium: One Commodity Case Purchase of a commodity by a consumer depends on three factors:  (a) Price of a commodity.  (b) Marginal utility of commodity.  (c) Marginal utility of money.  Marginal Utility of Money Marginal utility of money refers to worth of a rupee to a consumer. A consumer defines it in terms of utility that he derives from a standard basket of goods that he can buy with a rupee.  Diagram: One Commodity Case From the above diagram it is clear that (1) MUx is a downward sloping curve showing       that MUx declines as consumption of       commodity-X increases.  (2)Px indicates market price of commod
Read more