 We will continue our discussion on consumer theory or theory of consumer behavior in this session also. So, if you remember in the previous session, we talked about the assumption what is generally taken in the theory of consumer behavior or when we do the consumer behavior analysis. Then we introduce the concept of total utility, marginal utility, how both of them they are related to each other. And this is all the total utility and marginal utility this is only based on the perception of the consumer on the satisfaction what they get after consuming the product. Then we introduce the concept of law of diminishing marginal utility which tells us that when a consumer go on consuming a product after a certain point of time generally the marginal utility diminishes and sometimes it even reaches to 0 and sometimes you get it the negative marginal utility. Then we introduce the concept of indifference curve analysis which is a part of ordinary utility analysis and here we discuss about the different properties of indifference curve. Then what is the rate at which the goods get substituted with each other like the marginal rate of substitution. And also we discuss about the different kind of indifference curve like when the nature of goods are different like complementary goods or may be the substitute goods. So, in today's class we will carry out discussion on the budget line how the consumer incomes get limited by the consumer preferences. Then we talk about the consumer equilibrium keeping budget line the constant as the budget line or the budget constant. Then we will introduce the concept of law of equimarginal utility then we will discuss about the price income substitution effect and finally our discussion point will be on consumer surplus. So, what is a budget line? So, till the time we know that indifference curve gives us the consumer preferences and at the same point it also gives us the different combination of goods and services which gets the same level of satisfaction. Now, more is always better for the consumer, but when it comes to affordability of the consumer always the income pose as a constant. So, the consumer income is here we consumer income we represent in term of the consumer budget line and budget line describes the limits to consumption choice and depends on consumer budgets at the prices of the goods and services. So, it show all the possible commodity bundle that can be purchased at a given price with fixed money income. So, income is fixed budget line shows us the different kind of goods and services what the consumer can consume with this typical fixed income. So, in this case if you consider M is the money income and if the total consumption basket of the consumer is just consist of 2 goods X and Y then the total budget line will be represented in term of M which is equal to PXX plus PYY. Now, why this is only PXX and PXY we are assuming that the entire money income of the consumer is getting spend only on consumption of goods X and Y. So, PX is the price of X, PY is the price of Y. So, the X is the quantity of X and Y is the quantity of Y. So, entire money income is getting spend on X and Y and since it is equal to income the price of X and price of Y is also multiplied along with the quantity of X and Y. So, this is the graphical representation of the budget line and if you look at here we represent in the graph A and B as the budget line. Then at the point A if you get the value is equal to M is equal to PY and why you how you get the value of A at the point YXX is equal to M by PY because the entire money income is getting spend on only in the consumption of good one of the goods. Similarly, M by PX if you look at the other extreme here also the entire consumption is getting spend only on the consumption of the goods and services. Let us see how we can draw this budget line. So, if you remember this the budget line equation is PXX and PYY. So, if we assume that the entire money income is getting spend only on consuming Y then this term becomes 0 and if you solve for Y then you get the value which is M is equal to PY which we get here that is M is equal to PY. Then similarly if you spend the entire money income or if the consumer is spending entire money income only on consumption X then the second item becomes 0. So, this M is equal to PX by X and the value of X is M by PX. So, here we get the value which is equal to M by PX. So, if you join this two point what is the significance of this two points suppose this is A suppose this is B at this point A the entire consumption is entire money income is getting spend only on consumption of Y and at this point the entire money income of the consumer is getting spend on the consumption of X and in between all this point it gives us the different quantity of X and Y. So, any point in this range will give a mix of combination of goods X and Y whereas, this two extreme point gives us that when the entire money income is getting spend only on the consumption of the specific good in case of horizontal axis this is on the consumption of good X and in case of vertical axis in the consumption of good Y. So, indifference curve gives us the consumer preferences on goods and services and whatever the satisfaction they get out of it and budget line gives us what is the possible combination of X and Y can be consumed with a fixed money income of the consumer. We have simplified this analysis of indifference curve and the budget line to two goods just for the simplicity of it when you just take two goods otherwise also there is an option when you have more goods and services you can cluster them into specific groups and you can represent them in the indifference curve. So, we have introduced the concept of the indifference curve in the previous session and this session we have introduced the case of the budget line. With the help of this we will see how the consumer is reaching the equilibrium, but before analyzing the condition of consumer equilibrium we will see that in which case the budget line get changes. First when there is a change in the income so whenever there is a change in the income it increases of the in the income leads to a parallel outward shift in the budget line. Like if you look at the third line that is the increase in the income from the original budget line and decrease always in the downward direction. So, increase in the income lead to a right shift in the budget line and decrease in the income leads to a left shift in the budget line. So, one is upward in case of increase and downward in case of decrease. Now, what is the change in the budget line when there is a change in the price? A decrease in the price of good x rotates the budget line counter clockwise if you when you can see in the graph. So, the initial budget line is the black line and when there is a change in the price of the goods now with the same amount of money income the consumer can consume more of good x and because of this the budget line shift to the right. So, if you look at this case if you are considering here as the x here you are considering as the y this is the original budget line. Now, price of x decreases. So, with the same money income now the consumer can still have more quantity of x as the price of price of x has decreased. So, in this case the budget line will shift to the right this is the new budget line. So, this is a b this is a b 1. Now, suppose the price of y decreases now with the same money income now the consumer can have more quantity of y. So, at this point b remain constant now the curvature will change in case of y and suppose this is a 1 b. So, the new budget line is a 1 b if the price of y is decreasing. Now, it will move in the opposite direction if the price of x is price of x is increasing or price of x is price of y is increasing. This is the case in the previous case we analyze the decrease in the case decrease in the price of x and price of y and the scenario will change when the price of x will increase and or price of y will increase. Now, we will see how to reach the consumer equilibrium consumer equilibrium is the point this is the optimal consumption for the consumer and what is the optimization problem for the consumer the optimization problem for the consumer is to maximize the satisfaction. So, consumer behave rationally and would always aim to maximize the utility given the money income prices of the goods in the consumption basket. So, irrespective of the price of goods and services the income keeping this as a constant the consumer always behave rationally and they always see that how they can maximize the utility. It is a it is at a point where the budget line is tangent to the highest attainable indifference curve by the consumer subject to the budget constant. So, graphically how you get the point of consumer equilibrium it is at a point, but the budget line is tangent to the highest attainable indifference curve by the consumer subject to the budget constant. So, what is the consumer objective or what is the consumer optimization problem to maximize his or utility subject to the income constant. We have kept two goods in this case one is x another is y. So, the consumer consumption basket is consist of two goods x and y price of both the x and y are fixed like p x and p y are fixed consumer income is given. So, price x and y is fixed income is fixed two goods are there x and y and the consumer objective is to maximize his or her utility subject to the income constant. Now, what is optimal consumption? Optimal consumption is the point at which the consumer maximize the utility or where the utility maximizing takes place or that is the point of the consumer equilibrium. Now, what is the precondition for this optimality or what is the precondition for this utility maximization? It requires the slope of the budget line should be equal to the slope of the indifference curve. So, in the previous case if you remember the budget line is a b like right. So, at the point a this is we get a value that is m is equal to p y and at the point b we get a value which is equal to m by p x. So, corresponding to this what will be the slope of the budget line the slope of the budget line will be p x by p y and as we know previously that the slope of the indifference curve is marginal rate of technical substitution that is sorry marginal rate of substitution that is m r s x y which is also equal to the ratio of marginal utility of x and marginal utility of y. So, optimality requires the equality between the ratio of marginal utility and price of x which is equal to the marginal utility and price of y. So, we have two goods in this case price of x, price of y is fixed, income is fixed, the optimal consumption or the point at which the consumer will reaches the equilibrium at this point the ratio of marginal utility and price of x should be equal to the ratio of marginal utility and price of y. So, now if you look at in the graph at this point you look at the arrow mark this is the point of the consumer equilibrium. Why this is the point of the consumer equilibrium? Because this is the equilibrium consumption bundle is the affordable bundle that will the highest level of satisfaction. The consumer can pick up the combination in the indifference curve 1, the consumer can pick up a combination in indifference curve 2, the consumer can also pick up a combination of good x and y in the indifference curve 3. But the consumer since the optimality or since the optimization problem for the consumer is to maximize the satisfaction, maximize the utility that is the reason the consumer will reach the equilibrium at this at the point in the indifference curve 3. Because that gives a highest level of satisfaction and also the combination in indifference curve 3 can be achieved with the constant as the form of the budget line or constant in the form of the income. So, the straight line is the budget line there are three indifference curve and the consumer will always pick up a point in the highest indifference curve because that will give a higher level of satisfaction or the higher level of utility and that goes with the basic optimization problem with the consumer. Now, we will check what is the condition this consumer equilibrium in detail. So, del y by del x or ratio of marginal utility of x or y is the slope of the indifference curve. P x by P y is the slope of the budget line and what is the what is the preconditions or what are the condition for the optimal consumption that is ratio of marginal utility of x and y is equal to the ratio of price of x and y. So, if you look at there are three points point A, point B and point C all these three points the consumer is reaching the equilibrium because u 1 is one indifference curve, u 2 is the second indifference curve and u 3 is the third indifference curve. Similarly, we have three budget line b 1, b 2 and b 3. Now, suppose the consumer A has the income which is equal to b 1. Now, having the equilibrium b 1, the consumer can only pick a point in case of or only pick a combination in the indifference curve one that is u 1 and suppose the income increases for the consumer from b 1 to b 2. Now, the consumer can prefer a quantity or prefer a combination of x and y in the higher indifference curve that is u 2. So, that is another consumer equilibrium point at the point b. Similarly, when the price of b 3 increases or the sorry income of the consumer increases from b 2 to b 3 the consumer again can achieve a higher level of satisfaction by choosing a combination as indifference curve 3 that is u 3. So, if you join this 3 point a, b and c we reach to a path which is consumption path and why this is known as the consumption path because when the income increases this is the consumption pattern of the consumer and if you look at each equilibrium point the consumer maximized the satisfaction. So, after joining point a, b and c all these are consumer equilibrium points we get as the consumption path. So, consumer equilibrium is the point this is also known as the optimal consumption or this is also known as the may be the the best consumption for the consumer because they get a higher level of satisfaction or the highest level of satisfaction with the limited income with the fixed income and when the prices are also fixed and how this can be achieved there are two points to achieve this one at this point where the ratio of the marginal utility and price of x is equal to the ratio of marginal utility and price of y and geometrically this is at the point where the budget line is tangent to the indifference curve. So, consumer there is a equality between the ratio of the marginal utility and price of x and marginal utility and price of y. So, consumer allocates income so that the marginal utility per rupee spend on each good is same for all commodity purchase. So, like since there is a ratio is equal to ratio of one goods is equal to the another goods it can be said that the marginal utility per rupee spend on each good is same for all the commodities purchase. Till the time the equality is maintained then this is fine, but when the there is a disturbance in the equality or at any point of time the ratio of marginal utility and price of one good is greater than or smaller than the ratio of marginal utility and the price of the other goods in this case we can say that like in this case the ratio of the marginal utility of x is greater than price of x, price of x is greater than the marginal utility of y and price of y the consumer will spend more on good x and less on y because he is getting more marginal utility by spending on x as compared to y. The situation will again change if the marginal utility and price of y is greater than the ratio of marginal utility and price of x. In this case the consumer will prefer to spend more on good y as compared to x because the consumer is getting a higher level of satisfaction or higher level of utility by spending on good y because the marginal utility what he is getting by spending one additional rupees on it is giving a higher utility as compared to the additional utility that is getting from good x. So, if it is equality then the consumer is spending money in such a way because the marginal utility is getting that is equal, but sometime there is a mismatch the consumer always spend more money income on that good where they get a higher level of marginal utility. Now, we will take an example that how generally this choices are made when it comes to the decision making in term of the marginal utility. We will take a case of Jill that how much ice cream does Jill buy in a month. There are some facts this is limited income and there is also a opportunity cost involved of making a choice. Buying ice cream leaves Jill less money to buy other things each dollar spend on ice cream could be spend on the hamburger. So, how much ice cream Jill should buy it? There are few facts on this he cannot buy unlimited because there is limited income and also there is a opportunity cost associated with it whenever he is who is buying the ice cream because the same dollar or the same money income could have been spent on buying other goods like the case of the hamburgers. So, whether it is Jill or any other consumer they always make a comparison when before deciding on where they have to spend the money income. So, in this case if it is ice cream or it is the case of hamburger Jill has to decide on the basis of the marginal utility how much marginal utility he is generating when he is spending money on the ice cream or spending money on the hamburger for example. So, some more facts the price of hamburger and ice creams are market given the consumer cannot change the price of the goods Jill like any other rational consumer which has to maximize her utility. So, prices are given market give given consumer cannot change it and Jill maximize her utility because this is the general optimization problem for any rational consumer. The opportunity cost of one dollar spent on ice cream is the foregone utility for one dollar that could be spend on the hamburger because what is the opportunity cost here if he is spending one dollar on ice cream then the opportunity cost of this one dollar is to foregone the utility of one dollar that could be on hamburger. So, if he is not spending on the ice cream he could have got it on the he could have bought a hamburger. If the utility of one additional dollar of ice cream is greater than the utility of the last dollar spent on hamburger Jill can increase her total utility by spending one dollar less on hamburger and one dollar more on ice cream. So, it is like when he is getting more utility by spending additional dollar on ice cream rather than on hamburger in his next consumption what he will do he will reduce his consumption from hamburger and he will spend more on ice cream because he is getting a higher level of utility if he is spending on ice cream. So, here the decision rule is when he is spending or when any consumer is spending one more unit of money whether it is in the form of dollar in the form of the rupees whatever the additional utility they are getting and their decision always go for the product where they are getting a higher level of utility and the same is happening in the case of Jill even if she is spending both on ice cream and hamburger but if she is getting more utility in ice cream she will prefer to spend more on ice cream rather than the hamburger. So, utility maximizing rule as it is say that there is a ratio of marginal utility of x and y. Similarly, if you take two goods here i and h the two good rule is the ratio of marginal utility and price of i it should be equal to the ratio of marginal utility of h and price of h the rational consumer would buy an additional unit of good h the perceived dollar value of utility of one additional unit of that good say marginal dollar it is greater than its market price like till the time the ratio is equal the consumer is spending on both the goods. But when it comes to there is a inequality as we discussed in a brief before few minutes if there is a inequality the consumer always spend more on the goods where they are getting a higher level of utility. Now, we will see how the utility maximizations takes place under an income constant consumer spending on consumer goods is constant by their income like here the if you can look at the budget line equation is p x q x plus p y q y or p w q w or p z q z and the income the income constant or the budget constant consist of the price of the goods and the quantity of the goods. So, that what can be purchased with a fixed money income. So, in this case even if the consumer tries to always the equal the ratio of the marginal utility and the price of all the goods so that they can spend equal amount of money on all the goods, but to maximize her total utility if it is a case of jail her total spending cannot exceed her income for example, with an income of 86 dollar jail is trying to decide how much ice cream and how much hamburger she should buy. So, if jail income is 86 then he can she can consume both the goods may be ice cream and the hamburger. So, if it is 5 multiplied by 10 plus 6 multiplied by 6 then it comes to 86 rupees. Now, we will see how we get this number 5 10 6 and 6 which one is the unit and which one is the price and what is the requirement for here we should know what is the price of ice cream we should know what is the price of hamburger we should know what is the money income what jail is having. So, we know that the jail is having the income which is equal to 86 dollar. Now, we will see with the help of 86 dollar how much unit of ice cream or how much unit of hamburger jail can buy with the income and whether after this she is reaching the optimization or she is reaching the optimal consumption or not. So, this is the example of the quantity the price of both the ice cream and hamburger. So, the first column gives us the quantity the second columns gives us the marginal utility of ice cream the third column gives us the price of ice cream the fourth column gives us the ratio of marginal utility and price of ice cream the fifth column gives us the marginal utility of hamburger the sixth column gives us the price of hamburger and the last column gives us the ratio of the marginal utility of hamburger and price of hamburger. Now, if the price is 10 for is 10 for ice cream and 6 for hamburger then how many units of ice cream, jill should buy and how much unit of hamburger jill should buy. What is the ratio? The ratio is again if you remember the equality condition. Optimal consumption is 1 where the marginal utility and price of both the goods has to be equal. So, in this case in which case we are getting the marginal utility and price of goods is equal either at the unit 5 when the 5 unit of where the price is 10 rupees and price of ice cream is may be 10 dollar and price of hamburger is 6 dollar. Now, looking at this if you plot it in a budget line when the entire 86 rupees is getting spent on ice cream then the value of y is 8.6 because price of ice cream is 10 dollar and with the help of 86 dollar the consumer can only buy 8.6 unit of ice cream and if the consumer is buying hamburger only hamburger then in this case the consumer can buy 14.33 unit of hamburger because price of hamburger is being fixed at 6 rupees. So, 2 extreme, 1 extreme 8.6, the other extreme 14.33 and what is the optimal consumption? The optimal consumption when the consumer is buying 5 unit of ice cream and 6 unit of hamburger. So, price of ice cream is 10 rupees 10 dollar. So, it comes to 5 units. So, it comes to 50 dollar and price of hamburger is 6 dollar when the consumer is spending 6 unit on hamburger that gives us the 36 dollar. So, 50 plus 36 that gives us the 86 dollar and what is the slope here? Slope here is 6 by 10 because 6 is the price of hamburger and 10 is the price of the ice cream and that comes to 0.6 as the slope. So, if you look at now what is the optimal consumption? The optimal consumption is 5 unit of ice cream and 6 unit of hamburger which gives the level of satisfaction to zeal and also this fits within the income that is 86 dollar. So, if you recall the utility maximizer rule this is always the ratio of the 1 goods as compared to the ratio of the other goods and if price of x increases this equality would be disturbed. It is not only the utility will disturb this equality also when there is a change in the price that will also disturb the equality. So, mu x p x will be less than mu y p y if there is an increase in the price of x and the similar thing will happen also if there is a change in the price of y. So, to return to equality the consumer must adjust his or her consumption. Have in mind that the consumer cannot change the price or his he has an income constant. Then what are the consumer options? If there is a mismatch to reach to the optimal consumption the consumer has to adjust his or her consumption. Here we need to remember here is that the consumer cannot change the price the consumer cannot change the income available to him. Now, what are the consumer options? In order to make the two sides of the above inequality equal again given that p x p y could not be change we could have to increase mu x and decrease mu y. Recalling the law of diminishing marginal utility we can increase mu x by reducing x and we can decrease mu y by increasing y. Then we will come to the what happens to when there is a change in the price what it leads to because if you remember the budget line shifts whether it also shift the consumer equilibrium whether it also shift the consumer preferences with the change budget line that will analyze to the price income and the substitution effect. So, if decrease or increase in the price of a good has two effects one consumer will tend to buy more of the good that has become cheaper and less of those good that are now relatively more expensive. So, in case of decrease in the price consumer will tend to buy more of the good that has become cheaper and less of those good that are now relatively more expensive because one of the goods is now cheaper consumer enjoy in the increase in the real purchasing power like if you remember your shift in the budget line. If price of x is decreasing that leads to the shift in the budget line in the horizontal axis because with the same money income now purchasing power of the consumer has increased and the consumer is buying more amount of x. So, any change in the price it has two effect one the consumer buy more of these goods where the price has gone down and less of those goods which become expensive now. Now, we will see we will analyze the change in the price and we will see that how the effect of change in the price is equal to the substitution effect income effect and the equal the price effect is equal to the substitution effect and income effect. So, if you look at look at the graph the consumer is initially at A on the budget line RS. Now, we are considering food on the x axis clothing on the y axis and the consumption basket consists of only food and clothing two items. The consumer is initially at the point A at the budget line RS. When the price of food decreases then the budget line shift to the right. Now, how this budget line shift to the right? Because there is a decrease in the price of food that leads to the purchasing power of the consumer and by which they can buy more of the food now that is the reason the budget line will have shift to RT. So, when the price of good falls the consumer increases by F 1 F 2 as the consumer moves to B. Now, what is the increase in the quantity that is F 1 and F 2? When the now what are the options? The consumer with the new budget line the consumer moves to a higher budget line and ideally the consumer should also consume more. Now, we will see that how this consumption of more of x will lead to some adjustment in the purchasing power of the consumer some adjustment in the consumption pattern of the consumer. So, initially the budget line is AB and the consumer was suppose this is the indifference curve the consumer was equilibrium at this point may be suppose this is E. Now, if you are considering here x and here y price of x decreases when there is a decrease in the price of x that leads to change the budget line from AB to AB 1 because now with the help of the reduced price the consumer can buy more of x. With the new budget line the consumer can achieve or consumer can choose a combination at the higher indifference curve U 2 because U 2 will gives us a higher level of satisfaction. Let us consider this point now what the consumer will try to do? If the consumer is still want the same level of satisfaction then in that case we have to draw a parallel line by compensated demand curve and what is this compensated demand curve? This compensated demand curve is reducing the same amount of income what has been reduced as the or what has been increased by the real purchasing power. So, by this now the budget line shift to C D and which is again at the consumer can prefer a combination or the consumer can be equilibrium at this point E 1. So, this movement from E to E 2 this is because of price effect the movement from E 2 to E 1 this is because of the income effect because there is a reduction in the income effect by the compensated demand curve and this movement from E to E 1 is the substitution effect. So, now how this entire may be the entire process of income substitution and price effect work? Initially the consumer is equilibrium at this point E price of x decrease and increases the consumer moves to a new budget line that is from AB to AB 1. With the new budget constraint with the new income constraint the consumer can now consume a combination or choose a combination on a higher difference curve U 2 and with this the consumer moves to a new a consumer equilibrium point E 2. The movement from E to E 2 is the price effect because this change is due to change in the price. Now to bring back the consumer to the original satisfaction level there is a reduction in the money income by the compensated amount by which there is a increase in the real purchasing power that leads to the shift in the budget line the parallel shift in the budget line from AB 1 to C D. With the new budget line still the consumer can choose a combination which is equal to E 1 and this is the new consumer equilibrium for the consumer. So, the movement from E 2 to E 1 is due to change in the income that is the reason it is known as the income effect and the movement from E to E 1 is because of the substitution because effect because there are few substitution has been done and that is the reason the movement is from E to E 1 that is the reason it is known as the substitution effect and the price effect that is E to E 2 is always the combination of the substitution effect and income effect. Now what is substitution effect? Substitution effect is E E 1 and income effect is E 1 E 2. So, price effect is always a combination of income effect plus substitution effect let us go back to the graph what we are showing in the slide again. So, initially the consumer is at the point A and when the price of food decreases consumption increases by F 1 F 2 as the consumer moves to point B and it is on a higher difference curve U 2. The substitution effect F 1 E associated with a move from A to D that is change in the relative prices of food and clothing, but keep the real income the satisfaction constant like what we did in case of the graph that is E movement from E to E 1 because the satisfaction has to keep constant and that is the reason the real income has to constant and that that is the reason there is a decrease in the budget line by the amount by which there is a increase in the real purchasing power. The income effect is E F 2 associated with a move from D to B keeps the relative prices constant, but increase in the purchasing power. Food is the normal good because the income effect E F 2 is positive and if it is negative then this is a inferior good because the logic here is that for the normal goods always the income increases when there always the consumption increases whenever there is a increase in the income. So, substitution effect is the change in the consumption of goods associated with the change in its price with the level of utility held constant and income effect is the change in the consumption of the good resulting from an increase in the purchasing power with relative prices held constant. So, in the previous graph the price effect is F 1 F 2 which is equal to the substitution effect that is F 1 E and income effect that is E F 2. So, let us take a numerical to understand the concept of price effect, income effect and the substitution effect. So, we have information about the price of X and Y, we have information about the quantity of X and Y, we have information about the income and also we have information about the utility what the consumer receives when they consume a specific combination of good X and Y. So, suppose we have taken the case of two goods that is X and Y which is the part of the consumption basket. So, the first one is price, second one is quantity, then income, then utility. So, price again we have price of X, price of Y, quantity of X, quantity of Y, then income is same for both the goods and utilities again same. So, in the first case price of X is 10, price of X is 10, price of X is 10, price of Y is 10, price of Y is 5, price of Y is 5, then quantity of X is 50, quantity of Y is 40, quantity of X is 48, quantity of Y is 84, quantity of X is 40, quantity of Y is 70, income is equal to 900, income is equal to 900, income is equal to 750, utility is 100, utility is 150, utility is 100. Now, we will find out the price effect, we will find out the income effect and we will find out the substitution effect. Now, how we will find out the price effect? Then the price of Y decreases from 10 to 5, holding the income constant, the quantity demanded of Y increases from 40 to 84. So, price of Y decreases from 10 to 5, we have to keep the income constant, the quantity of Y increases from 40 to 84. So, what is the price effect? The price effect is the change in the quantity demanded when there is a change in the price of the goods. So, in this case the price of good is changing from 10 to 5, which leads to increase in the consumption of Y from 40 to 84, even if the income constant, there is a increase in the purchasing power of the consumer because of decrease in the price of Y and that is the reason the price of price effect is equal to 44. Now, we will see how we can find out the income effect and the substitution effect. Now, substitution effect if you remember, both the utility has to be same, even if there is a decrease in the income. Like in the graph, even if you draw a compensated budget line from the previous budget line to the like to the original budget line. So, the utility level has to remain constant because the next point also was on the same indifference curve. So, in this case 100 is the utility, 100 is the utility. Keeping the utility level constant, the difference between the quantity of good Y in both these cases will give us the substitution effect. So, substitution effect is equal to 70 minus 40, which is equal to 30. So, what is the logic for calculating the substitution effect? The utility has to be remain constant and what is the change in the quantity of Y? So, in the initial case if you remember the graph, the point where you move from E to E 1, even if both of the satisfaction level is same, but there is a change in the quantity of Y and that same change is represented here between 40 and 70 and that is the reason the substitution effect is 30. Now, we will find out the income effect. How to find out the income effect? Here the income effect is, when there is a change in the income, what is the change in the quantity demanded? So, here the income is decreases from 900 to 750 and the consumption of Y decreases from 84 to 70, which is equal to 14. Now, we will check whether the price effect is equal to the income effect or substitution effect or not. So, price effect is equal to substitution effect plus income effect. So, in this case price effect is 44, which is equal to 30, which is the substitution effect and 14, which is equal to the income effect that comes to the equality between the summation of price effect, substitution effect and income effect, which is equal to the price effect. And here the nature of the good is normal because the income effect is positive. Next, we will introduce the concept of consumer surplus. This actually measures that what the consumer is willing to pay for the good and what the amount actually paid. So, how this consumer surplus and demand they are related? Consumer surplus is, if you look at its derived from the, what is the market demand? So, consumer surplus is the total benefit from the consumption of a product less the total cost of purchasing it. So, here is the consumer associated with the six concert tickets purchased at 14 per ticket is given by the yellow shaded area. So, like if you look at this is the price, this is the quantity, this is the demand curve, this is the market price, which is equal to P m, this is Q m. So, this is Q 1, this is Q 2, this is Q 3. Now, to purchase this Q 1 amount of the quantity, the consumer is ready to pay P 1. To purchase this Q 2, the purchase the consumer is ready to pay P 2 and the to purchase Q 3, the consumer is ready to pay P 3. But since P m is the market price, the consumer is only paying P m irrespective of whatever quantity they are buying whether Q 1, whether Q 2 and whether Q 3. And because of this, the consumer is getting some surplus, because what actually he is paying and what he is ready to pay, there is a difference between this. He is ready to pay P 1, but he is paying R 1. He is ready to pay P 2 in this case, but he is paying R 2. He is ready to pay P 3, but he is paying R 3. So, this is the amount of the benefit, this is the amount of the surplus, what the consumer is getting and this is known as the consumer surplus. So, consumer surplus is nothing but what the consumer is actually ready to pay and what actually he is paying in the form of the market price that gives us the consumer surplus. Now, what happens when there is a increase or decrease in the market price? So, if you take in the previous example, this is our market price which is equal to P m and this is the total consumer surplus area. Now, suppose the market price is increased from P m to P m 1. Now, what would be this? With this, the quantity that is demanded in the market will be Q m 1. So, earlier the consumer surplus was this much. With the increase in the market price, the consumer surplus is the small triangle because there is a market price has increased from P m to P m 1. So, this is this area is the loss in the consumer surplus due to change in the price or due to increase in the price. So, this loss in the consumer surplus is two part. One part which goes directly to the producer and how it goes directly to the producer because with the increase in the price, they get in the form of the revenue and this is part of the producer surplus. However, this small triangle, this neither goes to the consumer account nor goes to the producer account and that is the reason this is known as the dead weight loss. So, when there is an increase in the market price, there is an increase in the market price from P m to P m 1, there is a decrease in the quantity demanded, the market demand that is Q m 1 and with the increase in the market price, there is a loss in the consumer surplus, there is a decrease in the consumer surplus area and the new consumer surplus area is the small triangle. The loss in the consumer surplus area has two part. One is producer surplus which goes directly to the producer in term of increase in the revenue, but the small triangle is one where it neither goes to the consumer because the consumer has reduced its consumption from Q m to Q m 1 nor it is getting sold by the producer and that is a reason this is known as the dead weight loss because it neither goes to the consumer account nor it goes to the producer account. So, consumer surplus is nothing but the change in the nothing but the what the consumer is actually paying and what he is willing to pay for the product and the consumer surplus changes when there is an increase in the market price and the loss in the surplus has two parts. One which goes directly to the producer account in term of increase in the revenue and second is the dead weight loss because it neither goes to the producer because it is not getting sold and neither it comes to the consumer because consumer is also not paying for the price. So, if in this particular graph because a price increase to P 1, the red triangle is the new consumer surplus area, the green one is the producer surplus that is consumer paying more and the orange triangle small triangle is the dead weight loss because it neither goes to the consumer account nor it comes to the producer account. These are the session references that is being followed for this typical session.