Question

A consumer consumes only two goods A and B and is in equilibrium. Show that when price of good B falls, demand for B rises. Answer this question with the help of utility analysis

Answer 1

Utility Analysis:

The consumer reaches equilibrium only if the following condition is satisfied

`(MU_A)/P_A=(MU_B)/P_B`

Give that the utility received from each additional units of money spent on both the goods should be equal. The marginal utility of the amount spent on good A is equal to the marginal utility of the amount spent on good B and also equal to the marginal utility of money.

`(MU_A)/P_A=(MU_B)/P_B=MU_m`

if the priceof good B falls in relation to good A, the consumerwillbuymoreof good B.

`(MU_B)/(P_B)>(MU_A)/P_A=MU_m`

The consumption of good B will tend to increase till the equality is established between the marginal utilities of both the good become equal to the marginal utility of money.