What is the Difference between “Price Effect” and “Price Consumption Curve”? – Explained!

The consumer purchases such a combination of commodities on the budget line from which there is no tendency for change or rearrangement. However, if the price of only one commodity (say, ‘X’) changes, with everything else including consumer’s income remaining unchanged, the consumer equilibrium will shift to a new budget line.

The point of equilibrium corresponding to each price change will be given by the point at which the corresponding budget line touches the highest possible indifference curve. With every change in the price of commodity ‘X’, the budget line changes its slope, but its starting point on the Y-axis remains the same, as the price of commodity ‘Y’ is assumed to be constant.

In other words, the purchasing power of the consumer in terms of commodity ‘Y’ remains unchanged, equal to OA. For fall in the price of commodity ‘X’, the budget line swings to the right and becomes flatter and flatter (as P_x/P_y falls). On the other hand, when the price of commodity on the horizontal axis rises, the budget line will rotate about a pivot point on the Y-axis clock wise (to the left).

In limiting case, when the price of commodity ‘X’ rises to infinity, the budget line coincides with the Y-axis. In this case, the consumer is forced to buy commodity ‘Y’ altogether and decides not to buy commodity ‘X’ at such a high price.

Therefore, it can be said that the price consumption curve starts from that point on the axis (‘X’ or ‘Y’), whose price remains unaffected and moves to those points, where price of commodity changes.

In Fig. 5.29, initial consumer equilibrium is shown at point E₁, where the original budget line AB touches the highest possible indifference curve IC,. Suppose the price of commodity ‘X’ falls, the budget line shifts to the right from AB₁ to AB₂. The new budget line is tangent to a higher indifference curve IC₂ at point E₂. The new equilibrium of the consumer at point E₂ in Fig. 5.29 is to the right of point E₂.

This shows that the consumer buys more of a commodity ‘X’, as the price of commodity ‘X’ falls. He has become better off, i.e., his level of satisfaction has increased as a result of the fall in the price of commodity ‘X’.

When the price of commodity ‘X’ further falls, the new consumer equilibrium point is point of contact (E₃) between the new budget line and the still higher indifference curve IC₃. When all these equilibrium points are joined together, what we get is called as price consumption curve.

Thus, price consumption curve is the curve formed by connecting the various points of consumer equilibrium, depicting the most preferred combinations of the two commodities, when the price of one commodity (or price ratio) is varied and all other things are kept constant.

Price consumption curve traces out the price effect, which measures the effect of the changes in the price of one commodity (commodity ‘X’ in this case) on the consumer’s demand of this commodity, when the price of other commodity, consumer’s income and tastes as well as preferences remains unchanged. In Fig. 5.29, the movements from E₁ to E₂, and to E₃ indicate the price effect.

The shape of the price consumption curve (PCC) depends on the amount spent on commodity ‘X’, when its price falls. With amount spent on commodity ‘X’ rising, PCC will be downward sloping. When amount spent on ‘X’ is constant, PCC will be horizontal. Lastly, with amount spent falling, PCC will be upward sloping. These different cases are discussed below in details.

The price consumption curve (PCC) depicted in Fig. 5.29 is downward sloping. In this case, the consumer demands a larger quantity of commodity ‘X’ and a smaller quantity of commodity ‘Y’ if the price of commodity ‘X’ falls.

When the equilibrium of the consumer shifts from point E₁, to point E₂ due to fall in the price of commodity ‘X’, the quantity demanded of commodity ‘X’ rises from OX₁ to OX₂ and the amount spent on this commodity rises from AY₁ to AY₂.

Since, with fall in the price of commodity ‘X’, the expenditure on this commodity rises, the price elasticity of demand for commodity ‘X’ (by total outlay method) is greater than one. This implies that when PCC is downward sloping, the demand for commodity ‘X’ is elastic.

Upward sloping price consumption curve (PCC) is another possibility. In this case, as the price of commodity ‘X’ falls, the quantity demanded of commodities ‘X’ as well as ‘Y’ rise.

Though the quantity demanded of commodity ‘X’ increases, when its price falls, but the expenditure on this commodity falls from AY, to AY₂. Hence, the demand for commodity ‘X’ is inelastic. (Fig. 5.30).

Price consumption curve for a commodity can take horizontal shape also. It means that as the price of commodity ‘X’ falls, its quantity demanded rises proportionately, but, quantity demanded of commodity ‘Y’ remains the same. Fig. 5.31 illustrates horizontal price consumption curve. In this case, the expenditure on commodity ‘X’ remains unchanged at AY₁. Therefore, by total outlay method, the commodity has unitary elastic demand.

Generally, price consumption curve has different slopes at different price ranges. At higher price levels, it usually slopes downward. .It may, thereafter, have a horizontal shape for some price ranges.

However, it ultimately slopes upward. To some price ranges, it may be backward sloping, as in the case of Giffen goods. A price consumption curve (PCC) with different shapes and slopes is illustrated in Fig. 5.32.

In this figure, the PCC is downward sloping up to point E₃ The curve is almost horizontal between points E₃ and E₄ and rises thereafter. It becomes almost vertical between points E₇ and E₈ indicating very low elasticity. At the end, price consumption curve bends backward, depicting direct price-demand relationship.