4.3.5 Consumer response to a change in relative price
Following a decrease in the price of X from PX1
to PX2
in Figure 4.12, the consumer moves
from point a on IC1 to point b on the higher indifference curve IC2. The falling price of X
increases demand from X1 to X2. This is consistent with a downward-sloping demand
curve. In Figure 4.12 the demand for Y is not affected by the falling price of X and expenditure
on Y must therefore be constant. Further, since money income is constant then
expenditure on X must be the same following the price decrease. Price elasticity of
demand for X is therefore of unitary elasticity, the proportional decrease in price leading
to an equal proportional increase in demand. This could also have been seen by imagining
the vertical axis to represent expenditure on all other goods than X.
The outcome in Figure 4.12 is a special case. A fall in the price of X could result in
the expenditure upon Y (or on all other goods) either increasing or decreasing. The
outcome depends upon the slope of the indifference curves, reflecting the preferences