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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
Solution
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.
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