Price Effect Analysis: Identifying Constant Factors

The price effect refers to how a change in the price of a good influences the quantity demanded. Understanding what remains constant is key to analyzing this effect.

Key Economic Concepts Defined

• Money Income: This is the actual amount of money a consumer possesses or receives. It's the nominal amount.
• Real Income: This represents the purchasing power of money income. It indicates how many goods and services can be bought with the available money. Real income changes when prices change.
• Price Ratio: This is the relative price of one good compared to another (e.g., the price of apples relative to the price of oranges).

Reasoning for Constant Factors

When explaining the fundamental price effect, the standard economic approach assumes that the consumer's actual money income does not change. A change in the price of a specific good directly impacts the consumer's real income (their ability to buy goods and services). The price ratio between goods inherently changes if the price of one good changes relative to another.

Therefore, in the context of the price effect:

• (a) Real Income: Changes as the price changes (its purchasing power fluctuates).
• (b) Money Income: Remains constant.
• (c) Price ratio: Changes if the price of one good changes relative to another.

Based on this, only money income (b) is constant.