THECONCEPTOFELASTI

CITY

El
asti
cit
y
Thi
srefer
stot
hedegr
eeofr
esponsi
venessofonev
ari
abl
etochangesi
nanot
herv
ari
abl
e.

Therearet
womaj
ort
ypesofel
ast
ici
tyandt
hesei ude:el
ncl ast
ici
tyofdemandandel
ast
ici
tyof
supply
.

Elasti
cit
yofdemand
Referstothepercent
agechangeinquanti
tydemandedofacommodityari
singfr
om agiv
en
percentagechangeinit
sdet er
minant
s.Oritist hedegr
eeofresponsi
venessofquanti
ty
demandedofacommodi tyt
ochangesinit
sdeter
minant
s.

Wewi
l
lfocusont het hr
eetypeofel
ast
ici
tyofdemand:
 Priceel
asticit
yofdemand
 Crosselastici
tyofdemand
 Incomeelast i
cit
yofdemand

Pri
ceelasti
cit
yofdemand
Thisref
erstothedegr
eeofr
esponsi
venessoft
hequant
it
ydemandedofacommodi
tyt
oagi
ven
changeinit
sownpr i
ce.

i
.e.PED=-QxP
P Q1

Example:
Givent
hedemandschedul
ebel
ow,
cal
cul
atet
hePED

Px Qx
A 1,
100 500kgs
B 1,
200 450kgs

Pr
iceel
ast
ici
tyofdemandr
angesf
rom per
fect
lyi
nel
ast
ict
oper
fect
lyel
ast
ic.

1.Per
fect
lyi
nel
ast
i p.
c( e.
d=0)
 Thisiswher
eagi venchangei
sthepr
iceoft
hecommodi
tydoesnotaf
fectquant
it
y
demandedofthecommodity
.
Diagr
am

2.I
nel
ast
i P.
cdemand( e.
d<1)

Thi
siswhereagiven(
lar
ge)changei
npr
icel
eadst
oasmal
l
erpr
opor
ti
onat
echangei
n
quant
it
ydemanded.
Diagr
am

3.Uni
tel
asti
cdemand(P.
e.d=1)
.
Thisi
swhereagiv
enchangei
npr
icel
eadst
oanequalchangei
nthequant
it
ydemanded
ofthecommodi
ty.
Diagr
am

4.Elast
icdemand(P.e.
d>1)
Hereachange( small
)inpri
cel
eadst
oamor
e(bi
g)pr
opor
ti
onat
echangei
nquant
it
y
demandedofthecommodit
y.
Diagr
am
5.Per
fectlyelast
ic(P. d=∞)
e.
Thisiswherequanti
tydemandedchangesi
nfi
nit
elywi
thoutachangei
npr
ice.
Diagram

Fact
orst
hatdeterminethesi
zeofpriceel
ast
ici
tyofdemand(
tobedi
scussedi
ncl
ass)
 Thelev
el ofaddi
cti
on(habi
tformi
nggoods).

 Thedegr
eeofnecessi
tyoft
hecommodi
ty

 Av
ail
abi
l
ityofsubst
it
utescommodi
ti
es

 Pr
opor
ti
onofi
ncomespentonacommodi
ty

 Thenumberofusest
hatcommodi
tyhas

 Dur
abi
l
ityofagood

Crossel
asti
cit
yofdemand
ThisMeasur
est hedegreeofresponsi
venessofquant
it
ydemandedofacommodi
tyt
oagi
ven
changei
nthepriceofanothercommodity.
CED= Q1xP2( ori
ginal
)
P2 Q1( or
igi
nal)
Ift
heval
ueofCEDi sposi
ti
ve,t
hecommodi t
iesar
esubstit
utesi
e,anincr
easei
npri
ceofone
l
eadstoareduct
ioni
nit
squanti
tydemandedbutanincr
easeinquant
it
ydemandedoft
heot
her
andvi
cever
sa

I
fthevalueofCEDi snegati
ve,t
hecommodi ti
esi
nquesti
onar
ecomplement
si.
e,ani
ncr
easein
t
hepriceofoneleadstoaf al
li
nitsquanti
tydemandedaswel
lasaf
alli
nquant
it
ydemandedof
i
tscounter
partbecausethetwoarej
ointl
yconsumed.

I
fCED=0,
thecommodi
ti
esar
enotr
elat
ed

Exampl
e

Incomeelast
icit
yofdemand( Y.
E.D)
Thismeasurest heper
centagechangeinquant
it
ydemandedofacommodi
tyar
isi
ngf
rom a
givenper
centageinaconsumer’
slevel
ofi
ncome.

I
ftheval
ueofYED isposi
ti
ve,thecommodit
yunderconsi
derat
ioni
sanor
malgoodi
e,an
i
ncr
easei
nincomel
eadstoanincr
easei
nthequant
it
ydemanded.

I
ft hevalueofYEDisnegat
ive,t
hecommodit
yinquestioni
saninf
eri
orgoodieani
ncr
easein
theincomeoftheconsumerl
eadstoadecr
easeinthequant
it
ydemandedoft
hecommodit
y.
I
fitiszero,t
henthecommodityi
saneut
ral
/necessi
ty
Exampl e

Comput
ati
onofel
ast
ici
tyusi
ngamar
ketmodel

THEORYOFCONSUMERBEHAVI
OUR
I
NTRODUCTI ON
Thetheor yofconsumerbehav i
orstudieshowaconsumerspendshi sincomesoast o
att
ainthehi ghestsat
isfacti
onorut i
l
ity
.Utili
tymaxi
mi sati
onbehavi
ouroft heconsumer
i
ssubj ecttotheconst r
aintimposedbyhi slimi
tedincomeandt hepri
cesoft hev ari
ous
commodi tieshedesirestoconsume.Theconsumercompar esthedif
ferent“bundlesof
goods”t hathecanconsumegi venhi sincomeandt hepri
cesoft hegoodsi nthe
bundles.Andi ntheprocess,heattempt stodeter
mi nethebundlet
hatwi l
lgivehimt he
maximum sat isf
acti
on.
CONSUMERS

Consumer sar
et heenduser swhoseekpr oductstoconsumeandsat i
sfytheirneeds
andwant s.Fr
om consumi ngpr oducts,theyder iv
eut i
li
tyorsat i
sfact
ion.Howev er,a
consumeri sli
mi t
ed wit
hf unds av ail
able and theref
ore she has to maximi ze her
sati
sfact
ionwhil
enotspendingmor et hanshehas.
Thelimit
ati
onoftotal
fundsav ai
l
ablet oanindividualdef
inesthebudgetconst r
aint.

UTILI
TY
Thisisthesati
sfacti
ononeget sfrom consumingacommodi ty.ORUtil
it
yref
erstot he
sati
sfyi
ngpowert hatagoodorser viceconsumedpossesses.Ut i
li
tyisdiff
icul
tt o
quantif
ysincei
tisapsy chologi
calfeeli
ng.I
tissubject
iveandit
spercepti
onvari
esfrom
onei ndi
vi
dualtoanot her. Thesat isf
acti
onMARY der i
vesfrom eati
ngamangoi s
dif
fer
entfrom t
hesat i
sfact
ionMICHAELf r
om eati
ngasi mil
armango.

MARGI
NALUTI
LITY

Thi
sref
erstot
headdi
ti
onsat
isf
act
ionder
ivedf
rom consumi
nganaddi
ti
onaluni
tofa
commodit
y.

Ut
il
it
ymeasur
ement

Thisisthequant
if
icati
onofthesati
sfact
ionofwant sandneedsachiev
edt
hrought
he
consumptionofgoodsandser vi
ces.Inpr i
nci
ple,thebehavi
ourofaconsumerthe
measurementofuti
li
tycanbeachi
evedusingthefol
lowingappr
oaches:
1.Car
dinalAppr
oach,
whi
chi
sbasedonnumer
icalv
alues(
1,2,
3,et
c.)and;
2.Or
dinal
Appr
oach,
whi
chi
sbasedonr
anki
ngs(
fi
rst
,second,
thi
rd,
etc.
).

Cardi
nalut
il
it
yt heory
Iti
sbasedont hemeasur ementofsat i
sfacti
oninnumeri
calv alues(1,
2,3,et
c.)i
nunits
knownasut i
ls.I faconsumeri maginesthatgoodXhas3ut i
lsandgoodYhas2ut i
l
s,
thengoodXisf oundtoprovidemoresatisfact
iont
otheconsumer .
Thismeansthataconsumercant el
lexactlyhowmuchsat i
sfactionshecanderi
vefr
om
theconsumptionofacer taingood.Howev er,t
hesubj
ecti
venat ureofuti
li
tymakes
cardi
nalmeasur ementunlikelyandt
hussomeeconomi st
shav esuggestedthatut
il
it
yis
measur
edi
nmonet
aryuni
ts,
byt
heamountofmoneyof
fer
edf
oracommodi
ty.

Assumpti
onsofcar di
naluti
li
tyapproach
1.Theconsumeri srati
onalwhomeasur es,cal
cul
ates,chooses,andcomparest
he
uti
l
iti
es of dif
ferent uni
ts of the vari
ous commodi ti
es and aims at t
he
maximizat
ionofutil
it
ygivenhisincomeandthepricesofthecommoditi
es

2.Thet
heor
yassumesconsumpt
ionofonl
yonecommodi
ty

3.I
talsoassumesthatal
lcommodi
ti
esav
ail
abl
etot
heconsumerar
eper
fect
lydi
vi
sibl
e
i
ntosmall
eruni
ts.

4.Uti
lit
yis measurabl
e;t hatthe uti
l
ity
/l evelofsatisfact
ion der i
ved fr
om a
commodityismeasur able,t
he mostconv enientmeasur e being money.The
cardi
nal
i
stsassumedthatoneut i
l=1unitofmoney.Uti
l
itythereforeisdenotedby
themonetaryuni
tsthatt heconsumeri swill
i
ngt opayf oranot herunitofthe
commodity.

5.Uti
li
tyisadditi
ve;car
dinal
i
stsbel
iev
ethatutil
i
tyderiv
edf r
om vari
ousgoodsand
ser
vicesconsumedbyaconsumercanbeaddedtoget
hertogett
hetot
alut
il
it
y.

6.Const
antMar gi
nalUtil
it
yofmoney ;thisappr oachassumest hattheMU of
moneyr emainsconstantwhat evert
hel evelofaconsumer si ncome.Thisi
s
i
mportantbecauseifmoneyi st obeusedasameasur eofutil
it
y,itshoul
dbea
st
andardv al
ueinordert oy i
eldmeaningfulresult
s.Theessenti
alfeatur
eofa
st
andardmeasur ei
sthatitshouldbeconstante.g.
,ameter,
mileetc

7.Dimini
shi
ngMU;ut
il
it
ygai
nedfr
om successi
veuni
tsofacommodi tydi
mi ni
shes
i
.e.
,theMUdi
mini
shesast
heconsumeracqui
resl
argerandl
argerquant
it
iesofit
.

Thelaw ofdimini
shingmarginalutil
it
yst atesthat“asmor eandmor eofasi ngl
e
commodityisconsumed,eachaddi t
ionalunitconsumedpr ovidestheconsumerwi t
h
l
essaddit
ionalsat
isf
acti
onthant heprecedingunitsucht hattotalut
il
it
ywilli
ncr
ease
uptoamaximum levelt
henitwillfal
lwhenmar ginalut
il
it
ybecomesnegat i
ve.

8.Theconsumer ’
sdeci si
on to consumei snotinfl
uenced byotherconsumersbut
depends ent
ir
ely on personalpreferences i
.e.
,the consumer
s uti
l
ityfunct
ion i
s
i
ndependentofotherconsumers’uti
li
tyfunct
ions
Totaluti
li
ty(TU)
Thi
si sthetotalamountofsat
isf
act
ionorpl
easur
eder
ivedf
rom consumpt
ionofagi
ven
quanti
tyofcommodi ty.

Forexample,i
faconsumerconsumes4unitsofacommodi
ty(
cooki
es)andder
ivesU1,
U2,U¬3,
andU4util
sfrom t
hefouruni
tseat
en,t
henTU=U1+U2+U¬3+U4.Thegener al
tot
aluti
li
tyf
uncti
onisgi
venby;TU=U1+U2+U3+.………+Un

+ + + +
Aconsumerwi
l
lgett
otal
uti
l
ityf
rom consumi
ngt
hesefourcooki
es.

I
foneconsumesacommodi t
y,t
otaluti
li
tyi
ncr
easesasconsumpt
ionincr
easesBUTup
t
oacert
ainpoi
nt,
from whi
chfur
therconsumpt
ioninst
eadl
eadst
oitsdecl
ine.

Tot
alut
il
it
ycur
ve(
il
lust
rat
ion)

MarginalUtil
it
y(MU)
Thisistheadditi
onalsat
isf
act
ionaconsumerderi
vesfrom anaddit
ionaluni
tofagi
ven
commodi tyconsumed.I notherwords,itisthechangei nTotalUtil
it
yasquantit
y
consumedchanges.MUi sgivenasachangei nt
otaluti
l
itydi
vi
dedbyachangei nthe
amountoft hecommodi t
yconsumed.Thatis;

MU=TU
Q

WhereTU =changei
nt ot
aluti
l
ityandQ =changeinquant
it
yofacommodi
ty
consumedt
husgi
vi
nguschangei
nconsumpt
ionbyoneuni
t.
Everysuccessiv
eunitofa commodit
ygivesa consumerl essand l
essaddi
tional
sati
sfact
ion,t
hatisMUkeepsonfal
l
ingforever
yaddit
ionalunitofacommodit
yt hat
oneconsumes.

> > >

MU1 >MU2 >MU3 >MU4

Not
e:MUi
sal
sot
hesl
opeoft
heTUcur
veatanypoi
ntoft
heTUcur
ve

Mar
ginalut
il
it
ycur
ve(
il
lust
rat
ion)

Cal
cul
ati
onMUf
rom TUandQ.

No. of Total Margi

nal
cooki
es uti
l
ity ut
il
it
y
(ut
il
s)
0 0
1 9
2 17
3 24
4 30
5 35
6 39
7 42
8 44
9 45
10 45
11 44
12 42

Fr
om thet
ableabove,
ther
elat
ionshi
pbet
weenTUandMUcanbei
l
lust
rat
edgr
aphi
cal
l
y
asbel
ow:i
ll
ustr
ati
on
Fr
om t
heI
ll
ust
rat
ionabovewenotethat;
 WhenTUisrisi
ng,
MUi sposi
ti
ve
 WhenTUreachesmaximum,MUr eacheszer
o
 WhenTUisdimini
shi
ng,MUisnegative
 Thehi
ghestpoi
ntoft
heTUcur veisknownasthepoi
ntofsat
iet
y.

Thesl
opeoft
heTUandMUcur
vesi
sduet
othel
awofdi
mini
shi
ngMU.

TheTUCur vei
ncreases,reachesamaxi mum (Pointofsatiety)andstar
tsfall
ing.TheMUf all
s
continuouslyupt ozeroandev encrossesint
onegat iveandt hisi
sbecauseoft helawof
diminishingmar gi
nalutil
i
ty.Atmaximum totaluti
l
ity(pointofsatiet
y)MUi szero.Thisi
mpl i
es
thatanyaddi ti
onalunitconsumeddoesnotaddanyut il
i
tytot heconsumer.Af t
erthepoi
ntof
sati
et y
,theTUCur vewil
lstarttof
allandanyadditionalunitconsumedwi l
lresulti
ntoadisuti
li
ty
ornegat i
v euti
l
ity.

Equi
l
ibr
ium ofaconsumerundert
hecar
dinal
uti
l
ityappr
oach

Marginaluti
l
ityreveal
stheval
ueaconsumerplacesoneachunitofacommodi t
yandthi
sv al
ue
i
srefl
ectedbyt hepr i
ceaconsumeriswil
li
ngtopayfort
hatunit
.Autil
i
tymaximisi
ngconsumer
wi
lladjusthi
spur chasesofacommodityunti
lthemargi
nalut
il
it
yfrom t
hatcommodit
yisequal
t
othepr iceofthatcommodi t
y.I
tiswri
tt
enasMux=Px

Equi
l
ibr
ium undert
hecar
dinal
uti
l
ityappr
oachi
sil
l
ust
rat
edbel
ow:
Li
mit
ati
onsoft
hecar
dinalut
il
it
yappr
oach

1.Thev eryfi
rstassumptionofcar
dinaluti
li
tyappr
oachthatuti
li
tyiscar
dinal
ly(
or
object
ivel
y)measurableisunt
enable.Uti
l
ityi
sasubject
iveconceptwhi
chcannot
bemeasur edobject
ivel
yorquant
ifi
ably.
2. Cardi
nalutil
it
yapproachassumest hatMU ofmoneyr emainsconstantand
ser
vesasameasur
eofut
il
it
y.Moneyi
snotagoodmeasur
eofut
il
it
ybecausei
t
changesv
alueov
ert
imeandi
tsMUi
snotconst
antaswel
l
.Poorpeopl
egetmor
e
ut
il
it
yfr
om auni
tofshi
l
li
ngcompar
edt
ori
chpeopl
e.

3.Theconsumer ’
sut i
l
ityf
uncti
onisnotindependentoftheut i
l
ityfuncti
onsofot her
consumer s.Aconsumermayconsumeundert heinfl
uenceofot herconsumers.
4.The assumpt ion ofdi mini
shi
ng marginalut i
li
tyis also nota mustf oral l
commodi ties. For some commodi ti
es, the consumer may der i
ve mor e
sati
sfacti
onasheconsumesmor eandthereforehemaybewi ll
i
ngt opaymor e.
5.Notallcommodi t
iesareperf
ect
lydi
visi
bleast hetheor
yassumes.
6.Thet heoryassumesconsumpt i
onofonecommodi t
y,whichi snotal way
st he
case.

Or
dinalUt
il
it
yAppr
oach(
OUA)
/Indi
ff
erenceCur
veAppr
oach
Moder neconomi st
se.g.Hickshav
eusedthisappr
oacht
oanalyzeconsumerbehavi
or.
Theyar gued thatitmaynotbepossi bl
ef oraconsumert o expr
esshisut i
l
ityin
quantitati
vetermsbuti tisalwayspossi
bleforhi
mt ot
ellwhichofanytwogoodshe
prefers.
Aconsumercanl i
stallthecommoditi
esheconsumesi ntheorderofhispref
erence
(scaleofpr ef
erence).

Thebasi
ct oolofanal ysi
si san“indiff
erencecur ve”
.Anindiffer
encecur v
ereferstoa
l
ocusofpoi nt
sshowi ngallpossiblecombi nationsoft wocommodi tiesthaty i
eldthe
samelevelofsat i
sfacti
ont oaconsumer .Theconsumeri sexpectedt obei ndi
ffer
ent
amongthedi f
ferentcombi nati
onst hatlieont hesamei ndiff
erencecurve.Thismeans
thatf
aced wi th a setofdi ff
erentcombi nations,the consumercan choose any
combi
nationsinceeachgi veshim equal sati
sf action.

Assumptions
1.Rationali
ty;t
heconsumerisassumedtoberational
-heaimsaymaxi
mizat
ionof
hisut i
l
ity
,givenhisincomeandmar ketpr
ices.Itisassumedt
hathehasf ul
l
knowledgeofallrel
evanti
nfor
mati
on

2.Uti
li
tyisordinal
;i
tist
akenthattheconsumercanr
ankhi
spr
efer
encesaccor
ding
tosati
sfact
ionofeachbasketofgoods.

3.Atl
eastt
wocommodi
ti
esar
econsumed.

4.Dimini
shingmargi
nalrat
eofsubsti
tut
ion;t
hisi
stheslopeofani ndif
fer
ence
curv
e.It’
st her
ateatwhichonecommodi t
yissubst
it
utedforanotherandit
dimini
shesasmoreofonegoodandl
essoftheot
herar
econsumed.

5.Transi
ti
v i
ty and consi
stency;t he consumer’s choi
ces are assumed t o be
tr
ansit
ive.Transi
ti
vi
tymeanst hatifaconsumerpr ef
ersAt oBandBt oC,he
mustpref erAtoC,or,i
fhet reatsA=BandB=C,hemustt reatA=C.consi st
ency
ontheot herhandmeanst hatifheprefersAtoBi noneperiod,hewillnotpref
er
BtoAi nanotherperi
odorev entreatthem asequal.

6.Non-
sat
iet
y;aconsumeri
snev
ersat
isf
ied,
alway
spr
efer
smor
etol
ess.

Howi
sut
il
it
ymeasur
edundert
hisappr
oach?I
tismeasur
edusi
ngi
ndi
ff
erencecur
ves.
AnIndi
ff
erenceCur
ve
I
ll
ustr
ati
on

Theslopeofani ndiff
erencecur
veisknownast hemar gi
nalrat
eofsubst it
uti
on(MRS)
.
TheMRSmeasur esther at
eatwhichonecommodi t
yi ssubst
itut
edf oranotherf
ora
consumertomai nt ai
nthesamel evelofsat
isf
acti
on.ThusMRSgi vest henumberof
uni
tsofcommodi tyYthatmustbegivenupinordert
ogetanext raunitofcommodityX
sothattheconsumerr emainsatt
hesamel ev
elofsati
sfact
ion

Pr
opertiesofindi f
ferencecur ves( il
lust rat i
onst obedonei nclass)
 AnI Chasanegat iv
esl ope,whi chi mpl iest hatast hequant ityofonecommodi t
y
(Y)decr eases;t hequant i
tyoft heot her( X)musti ncrease,i ftheconsumeri st o
remainont hesamel ev el ofsat isfact ion.
 AnI Chigherandt other i
ghtofanot herr epr esentsahi gherl evel ofsati
sfaction
 ICsar econv ext otheor iginwhi chi mpl i
esadi minishingmar ginal r
ateofsubst i
tuti
on
 ICsdonott ouchei t
heroft heaxes
 Bet weenanyt wopoi ntsonanI C, ther eexi stsmanyot herpoi nts
 Bet weenanyt woI Cst herear esev eral otherI Cs
 A col l
ection ofI Cs f orm an i ndi fference map.An i ndifference map i s a setof
i
ndi f
ferencecur v est hatar epar al l
elt oeachot hersi ncetheyr epresentdifferentutil
i
t y
l
ev el
s.Gi venani ndif
f erencemap, t hehi ghert heindifferencecur ve,t
hehi gherthel evel
ofsat i
sfactionandv icev ersa
 Indi f
ferencecur vesdonoti nter sect ,ift heydi d,theirpointofi nter
secti
onwoul d
i
mpl ysamel evelofsat i
sf actionont wodi ffer
entI Cs,whi chi si mpossible.Thi s
woul dalsov i
olatet heassumpt ionsoft ransiti
vit
yandconsi stencyasi llustrated
below
I
ll
ust
ration
Aconsumeri sindif
fer
entbet weenAandBsi ncet heybothli
eont hesameI C( i
c2)
.
Simil
arl
ysheisindif
fer
entbetweenAandCsi ncetheyal sol
ieonthesameI C(IC1)
.By
consi
stency
,itwouldimpl
yt hatsheisi
ndi
fferentbetweenBandCbutsi nceBl i
esona
hi
gherICthanCt henBispreferr
edtoCthusinconsistencyduetot
heintersecti
on

AlsosincepointBl i
esonahi gherindi
ff
erenceCurvethanpointCitimpli
esthatBi s
pref
err
edt oC( B>C).Ontheotherhandpoi ntsAandBl i
esonthesameI Cimpl
yingthat
theybothgiv
et hesamel evelofutil
i
ty(A=B).Simil
arl
yAandCl ieonthesameI C(IC1)
sotheyalsoyieldthesameut i
lit
y.Thenbyt heassumpti
onoftransi
ti
vi
ty,i
twouldimply
B=CbutB>Chenceacont radi
ction.

TheBudgetl i
ne( I
so-expendi ture)
Thisi sal i
net hatshowscombi nati
onsoft wocommodi ti
esaconsumercanaf fordwith
agi venl evelofincome,gi vent hepr i
cesofthesecommodi ti
es.Abudgetscheduleisa
tablet hatshowscombi nat
ionsoft wocommodi ti
esaconsumercanaf fordwit
hagi ven
l
ev elofi ncome,gi venthepr icesoft hesecommodi t
ies.Arat
ionalconsumerwouldlike
tor eacht hehi ghestpossiblei ndi
fferencecur
v eonhisindi
fferencemapbutshe/ heis
l
imi ted byi ncome,whi ch acts as a constrai
ntto maximi zi
ng ut
il
it
y.The income
const raint
/budgetlinefortwocommodi t
iesXandYcanbewr ittenas;
M=PXX+PYY
Wher ePX andPY ar ethepr i
cesofXandYr especti
vely
;XandYar et hei
rrespect
ive
quant i
t i
esandM i st heconsumer ’
sincome.

I
ll
ust
rat
ion

Shi
ft
sandt il
tsi
nthebudgetli
ne(BL)
Ashif
tinthebudgetl
ine
Theassumptioni
sthatonl
yincomeofaconsumerchangesandbot
hpricesar
econst
ant.
Thi
sisani nwardoroutwar
dmov ementoftheBLinwardsduetochangesinaconsumer’
s
i
ncomehol di
ngpri
ceofbothcommoditi
esconst
ant
.
I
ll
ust
rat
ion

Rot
ati
onsi
nthebudgetl
ine
Assumpt
ions
 Consumer
’si
ncomer
emai
nsconst
ant
.
 Thepr
iceofonecommodi
tychanges.
 Thepr
iceoft
heot
hercommodi
tyr
emai
nsconst
ant
.
 Thel
awofdemandi
sassumed.
Arot
ati
oninthebudgetl
i
neisanoutwardori
nwar
dti
l
tint
hebudgetl
i
neal
ongoneaxi
s
pi
vot
ingatonepointont
heotheraxi
s.
Whent hepr
icef
orcommodit
yXr educesl
eavi
ngthatofYandconsumer
sincome
unchanged,
thebudgetl
i
newil
lrot
ateoutwar
ds.
I
ll
ust
rat
ion;

Thi
smeansthatr
ealdisposabl
eincomeavai
l
abl
eforcommodi
tyXhasi
ncr
easedgi
vi
ng
hi
m/heranoppor
tuni
tytobuymor eofX.
Whent
hepr
icei
ncr
eases,
thel
i
ner
otat
esi
nwar
ds.
I
ll
ust
rat
ion;

Consumer sEqui
li
bri
um (uti
li
tymaximizat
ionundert
heOUA)
Aconsumeri sinequil
i
brium undertheOUAwhenhi sBList
angentt
othehi
ghestpossi
ble
i
ndif
ferencecurv
eonhisindiff
erencemap
I
ll
ustrati
on