Answer to Question #269702 in Microeconomics for Madhu Gupta

Question

Explain in detail the process by which the consumer arrives at an equilibrium

point. Illustrate this process through the concepts of budget line and

indifference curves. Using this framework, explain the income and

substitution effects for an inferior good when its price rises.

Answer 1

Consumer equilibrium is attained when the marginal utility obtained from the commodity equals one unit of the commodity's price.

Income and substitution for a commodity

When the price rises, it causes a change in the budget line. This reduces the purchasing power, and one buys fewer bananas as the budget curve shifts to B2. Consequently, the consumption reduces and shifts from point a to point c, and the quantity of bananas moves from Q3 to Q1