How does the Demand Curve clearly represent the Price-Demand Relationship?
The demand curve in the lower panel diagram can be derived from the upper panel diagram. Since demand curve shows a relationship between price and quantity demanded of a commodity, the lower panel, like upper panel diagram, still measures the quantity demanded of commodity ‘X’ on the horizontal axis.
However, the vertical axis in the lower panel measures the price of commodity ‘X’. Each point on the PCC corresponds to a particular quantity of commodity ‘X’. Every point on this curve also corresponds to a particular price of this commodity, though there are no prices on the Y-axis.
The price of commodity ‘X’ can be known from the slope of the budget line. It is, thus, clear that the PCC can provide information required to draw the demand curve, showing the quantity demanded of the commodity ‘X’ at various prices.
To derive demand curve from PCC, consider point of consumer equilibrium E, on budget line AB1. The quantity demanded at this point is OQ1. The price of commodity ‘X’ for this budget line is equal to money income (OA) divided by the number of units of commodity ‘X’ that can be bought with this money income (OB1). OA/OB1 or price of commodity ‘X’ in this case is equal to 60/20 or Rs. 3. At point E1 the consumer purchases 14 units of commodity ‘X’ by spending Rs. 42 (14 x Rs.3). and has left with a money income of Rs. 18 (Rs. 60 – Rs. 42).
Now, 14 units of commodity ‘X’ at its price of Rs. 3 becomes a point ‘R’ on the demand curve of the consumer, shown in the lower panel of the diagram. Similarly, from equilibrium point E2, the quantity of commodity ‘X’ demanded is OQ2, equal to 23 units and the corresponding price is OA/OB2 equal to 60/30 or Rs. 2.
Further, at equilibrium point E3, 32 units of commodity ‘X’ are demanded at a price of Rs. 60/40 or Rs. 1.50 (OA/OB3). These combinations of quantity and price of commodity ‘X’ are point ‘S’ and point ‘T’ respectively on the consumer’s demand curve depicted in the lower panel of Fig. 5.33. The demand curve for commodity ‘X’ is obtained by joining points ‘R’, ‘S’ and ‘T’. The demand schedule showing prices and quantities corresponding to these points is depicted in Table 5.3.
Thus, we observe that both the price consumption curve and the demand curve provide the same information, i.e., how much of a commodity would be demanded by a consumer at different prices. However, the techniques of drawing the two curves are different and they assume different forms. Some of the differences between the two curves are as follows:
(i) The price consumption curve (PCC) is drawn with two commodities ‘X’ and ‘Y’ represented on the two axes. On one of the two axes, instead of a commodity or commodities, money income can also be taken. On the other hand, the demand curve is drawn with quantity demanded of the commodity on the X-axis and its price on the Y axis. In the PCC, the price of the commodity is not explicitly mentioned.
(ii) PCC tells us the size of the consumer’s income and also the amount of money income left after the consumer has made the purchase of a commodity. The demand curve provides no such information, except that it is assumed to be constant.
(iii) PCC shows the total expenditure, when any number of units of a commodity are purchased. Price of the commodity can be calculated by dividing the total expenditure by the number of units of the commodity bought, when the entire money income is spent on it.
(iv) The price consumption curve clearly brings out separately the income and substitution effects of a change in the price of a commodity. The conventional demand curve does not attempt for splitting the price effect into income and substitution effects.