Question

discuss the links between the indifference curve, price elasticity estimates and the theory of supply and demand in economics (80%).

Answer 1

In order to understand the relationship let us first understand the income and substitution effect. The consumer will consume different bundles when its purchasing power changes. This effect is known as income effect. Likewise, the substitution effect are the changes in the consumption which happens due to the change in the relative prices.

In normal condition demand increases when the price fall whereas supply increases when the price rises. All this happen due to both income and substitute effect. We can say that we have inverse relationship between price and quantity demanded and a positive relationship between price and quantity supplied. Note that how responsive and sensitive is the relationship between the two variable is calculated by the price elasticity of demand and supply.

Now indifference curve shows all the different combination of two goods, the points between which a consumer is indifferent. If a consumer move along with this indifference cureve it will happen because of substitution effect and if the consumer jumps to a different indifference curve this will be because of income effect.