CONSUMER EQUILIBRIUM

CONSUMER: Consumer is a person who utilizes final goods and services to

satisfy his wants. Consumer will pay price only for those goods and services
which satisfy his wants.

UTILITY: It is the amount of satisfaction which the consumer gets by

consuming goods and services. Utility can be classified into Total utility,
Average utility and Marginal utility.

TOTAL UTILITY: It is the total amount of satisfaction which the

consumer gets by consuming total amount of goods and services.

AVERAGE UTILITY: It is the per unit satisfaction by consuming different

units of goods and services. It is calculated by dividing Total utility (TU) with
the number of units consumed.

AU = 𝑇𝑈
𝑁𝑜.𝑜𝑓 𝑢𝑛i𝑡𝑠 𝑐𝑜𝑛𝑠𝑢𝑚𝑒𝑑

MARGINAL UTILITY: It is the addition to the Total utility by consuming an

additional unit of the commodity. It can be calculated as MUn=TUn-TUn-1
∆TU
MU =
∆No. of units consumed

RELATIONSHIP BETWEEN TU & MU:

UNITS 1 2 3 4 5 6 7
TU 10 18 24 28 30 30 28
AU 10 9 8 7 6 5 4
MU 10 8 6 4 2 0 -2

(i) Initially TU increases but increases at diminishing rate and MU starts falling.
(ii) When TU achieves its maximum point, MU becomes zero. It is
also known as ‘Point of Satiety’ or ‘Point of Saturation’.
(iii) When TU start falling, MU become negative.
LAW OF DIMINISHING MARGINAL UTILITY (GOSSESN’S FIRST LAW OF
CONSUMPTION):
This law was pronounced by Professor Alfred Marshall. According to him as a
consumer consumes more and more units of a similar commodity without any
time gap then his satisfaction level goes on diminishing. For example, a
hungry man gets maximum satisfaction by consuming first unit of a
commodity, lesser satisfaction from second unit, much lesser satisfaction from
third unit and so on.

Assumptions:
 Price of the commodity and income of the consumer remains constant.
 Consumer consumes in continuous manner.
 Consumer behaves in rational manner. It means consumer wants more by spending
less.
 The taste and preference of the consumer will remain constant.

CONSUMER’S EQULIBRIUM:
Consumer’s equilibrium is a situation at which a consumer achieves maximum
level of satisfaction. So, How much of a commodity consumer buys so that he
maximizes his satisfaction and attains the point of equilibrium? This is
discussed with reference to two different situations:

(i) When only one commodity is consumed , and

(ii) When two commodities are consumed.

Consumer’s Equilibrium: Single commodity case (through utility approach)

If a Consumer wants to be equilibrium while consuming single commodity
then the following condition must be fulfilled:
MU (in terms of Money) = Price per unit

A consumer while purchasing a commodity compares its price with its

expected utility (in terms of rupees). Naturally he will buy the good only if
the benefit derived in the form of utility (in rupees term) is greater than or
equals to its price. Since it is difficult to compare MU of a good (in utils) with
its price (in Rs.). Thus, MU of a good is first converted in terms of rupees by
dividing it with the price per unit.

*What is MU of a rupee?

MU of one rupee is defined as the extra utility when an additional rupee is spent on the given

Now, the above mentioned condition of consumer’s equilibrium can be

explained with the help of an example. Suppose a consumer is consuming
‘paanipuri’ and his marginal utility schedule is given below. Further suppose

Units Price per unit(Rs.) MU of MU in Phase

consumed Paanipuri terms of
Money
1 4 40 10 MUof rupee>Price
2 4 32 8 MUof rupee>Price
3 4 24 6 MUof rupee>Price
4 4 16 4 MUof rupee=Price
5 4 8 2 MUof rupee<Price
6 4 0 0 MUof rupee<Price
7 4 -8 -2 MUof rupee<Price

Now the basic question arises: how many units of ‘paanipuri’ the
consumerwill purchase to achieve the equilibrium?

After consuming 1st unit of paanipuri, consumer will get Rs.10 worth of
satisfaction by spending only Rs.4. Hence, he must buy 1 st unit of paanipuri.
Similarly with the 2nd and 3rdunit, here consumer is getting Rs.8 and Rs 6
consumption, consumer is getting Rs.4 worth of satisfaction which is equals to
the per unit price of paanipuri (MU in terms of Money = Price). If the
consumer consumes more than four units, than his satisfaction level in terms
of Money will fall below than the price of the commodity. Thus, the consumer
will achieve equilibrium by consuming four units.
 MUX>Px: It means that the consumer is not at equilibrium and he keep
on consuming because the utility is greater than the price. As he buys
more, MU falls because of operation of law of diminishing marginal
utility and it will keep on falling until MU becomes equal to price.
 MUX<Px: This also means that the consumer is not in equilibrium and
he will have to reduce consumption of the commodity in order to raise
his total satisfaction till MU becomes equal to price.

Assumptions:
 Price of the commodity and income of the consumer remains constant.
 Consumer consumes in continuous manner.
 Consumer behaves in rational manner. It means consumer wants more by spending
less.
  The taste and preference of the consumer will remain constant.
 It is based on cardinal utility approach.
 Law of diminishing marginal utility is applicable.

Consumer’s Equilibrium: Double commodity case (Law of Equi-marginal utility

OR Gossen’s Second law of consumption)

In the case of two goods (say good X and good Y), a consumer attains
equilibrium when he spends his given income in such a way that per rupee
marginal utility of both the goods are equals to marginal utility of money.

𝑀𝑈𝗑 = 𝑀𝑈𝑦 = MU of money

𝑃𝗑 𝑃𝑦

We can explain this with help of an example, let the price per unit of good X
and good Y is `1 and the income of the consumer is 5.Here in order to get
maximum satisfaction consumer will spend his first rupee on good X (see the
table below), second rupee on good Y, then third rupee again on good X,
fourth on good Y and lastly fifth rupee on good X. At this point consumer
attains the equilibrium. At equilibrium consumer is going to consume 3 units
of good X and 2 units of good Y.

Rupee MU of good X MU of good Y

spent
1 10 (1st Rupee) 9 (2nd Rupee)
2 8 (3rd Rupee) 6 (4th Rupee)
3 6 (5th Rupee) 4
4 4 2
5 2 1

 What happens when the condition of equilibrium is not satisfied?

𝑀𝑈𝗑 𝑀𝑈𝑦
>
𝑃𝗑 𝑃𝑦
I.e. Per rupee MUx is higher than per rupee MUy. It means that consumer gets
more satisfaction by consuming good X. Now to consume more of good X
consumer will transfer his expenditure from good Y to good X. By consuming
more of good X, the utility of good X start diminishing because of law of
diminishing marginal utility. So consumer will start consuming less of good X and
more of good Y. The change continues still per rupee MUX becomes equal to per
rupee MUy.

𝑀𝑈𝗑 𝑀𝑈𝑦
<
𝑃𝗑 𝑃𝑦

I.e. Per rupee MUx is lower than per rupee MUy.It means that consumer gets more
satisfaction by consuming good Y. Now to consume more of Y consumer will
transfer his expenditure from good X to good Y. By consuming more of good Y,
the utility of good Y start diminishing because of law of diminishing marginal
utility. So consumer will start consuming less of good Y and more of good X. The
change continues till per rupee MUx becomes equal to per rupee MUy.

Assumptions:
 Price of the commodities and income of the consumer remains constant.
 Consumer consumes in continuous manner.
 Consumer behaves in rational manner. It means consumer wants more by spending less.
 The taste and preference of the consumer will remain constant.
 It is based on cardinal utility approach.
 Law of diminishing marginal utility is applicable.

BUDGET LINE AND BUDGET SET:

A budget line represents all the bundles (combination of two goods), which a
consumer can buy with his entire income and price of two goods. Budget line
separates attainable bundles from the non-attainable bundles. A budget set, is the
set of bundles which are attainable to the consumer. Consumer cannot afford any
bundle outside of the budget line.

Equation of budget line is: P1X + P2Y = M {Slope = Px/Py}

Where P1 shows the price per unit of good X and P2 shows the price per unit of
good Y, ‘X’ is the quantityof good X and ‘Y’ is the quantity of good Y. ‘M’
represents the income of the consumer. Slope of budget line is Px/Py.
Shift of Budget line:
A budget line can shift in many cases; some of them are as follows:
 When the income of a consumer increases then budget line shifts towards
right, whichindicates that purchasing power of the consumer has increased
(From AB to A’’B’’).
 When the income of a consumer decreases then budget line shifts towards left, which
indicates that purchasing power of the consumer has decreased (From AB to A’B’).

 When the price of good X decreases, budget line will rotate(from AB to

AB’) because, now consumer can consume more quantity of good X and the
quantity for good Y remains same and vice versa.
 When the price of good Y decreases budget will rotate (from AB to A’B) because, now
consumer can consume more quantity of good Y and the quantity for good X remains
same andvice-versa.

NOTE: Point A of the budget line represents the maximum quantity of good Y
which consumer can afford with his given income and it can be calculated by
dividing income of the consumer (M) and price of good Y {i.e. M/Py} And point
B represents the maximum quantity of good X which consumer can afford, it can
be calculated by {M/Px}.

INDIFFIRENCE CURVE: An indifference curve is a curve which shows all

those combinations of two goods (bundles) which gives equal level of satisfaction
to the consumer. And the different bundles on IC (like A, B& C in the figure) are
jointly known as indifference set.
Assumptions:
 The consumer is able to arrange available combinations of goods according to his
preference.
 The consumer behaves in rational manner.
 It is based on ordinal measure of utility.
 Marginal Rate of Substitution is Diminishing
 Non Satiety; It is assumed that the consumer will not achieve the
saturation and always prefermore of both the goods.

#Difference between ordinal and cardinal measure of utility

Cardinal utility Ordinal utility
This utility can be expressed in exact This utility can be expressed in terms of
units. Like, a ranking.
student gets 80 marks. Like, rank 1st for good X,2nd for good
Y etc.
It is helpful in determining equilibrium It is helpful in determining equilibrium
in one using
commodity and double commodity indifference curve analysis
case.

INDIFFERENCE MAP: An indifference map is a collection of indifference curves

corresponding to different level of satisfaction.

MONOTONIC PREFERENCE: It refers that consumer prefers more quantity of

goods rather than less, because more the quantity more will be the satisfaction.
Preferences of this kind are known as Monotonic preference. For example consider
a combination of two goods 2x+2y, this combination has more of both goods as
compared to 1x+1y, So the consumer prefers combination 2x+2y.

MARGINAL RATE OF SUBSTITUTION (MRS): MRS is the rate at which

the consumer is willing to give up units of one good to consume an additional
unitof another good without affecting the total utility.

PROPERTIES OF INDIFFERENCE CURVE:

(i) IC slopes downwards from left to right: IC is a curve at which all the
bundles of two commodities give equal level of satisfaction. It follows
that if a consumer wants to have more quantity of a good say X, then he
has to give up some quantity of the other commodity say good Y
in order to derive the same level of satisfaction.

(ii) IC is always convex towards the origin: The shape of the indifference
curve is convex toward the point of origin because of diminishing
marginal rate of substitution. Diminishing MRS means that consumer is
willing to sacrifice lesser and lesser units of one good in order to increase
the consumption of another good. Sacrificing ratio is falling because of
law of diminishing marginal utility.

(iii) Higher the IC represents higher satisfaction: This follows from the
‘more goods-more utility ‘property, popularly known as Monotonic
preference. In the figure, bundle ‘k’ contains ‘OY’ of good Y and ‘OX’
of good X. Bundle ‘k1’contains ‘OY1’ of good Y and ‘OX1’ of good X.
Clearly bundle ‘k1’ has more quantity than ‘k’. Therefore higher IC
represents higher satisfaction.
 (iv) IC cannot meet or intersect each other: Two ICs cannot cross each
other. This follows from the ‘transitivity’ and ‘monotonic preference’
properties taken together. In the figure IC1 and IC2 intersect each other at
point ‘C’. Bundle A&C lies on the same IC and hence provide same level
of satisfaction. Similarly, B&C lies on the same IC, thus by transitivity
bundle A&B should provide the same level of satisfaction. But it is
impossible because bundle A is better than bundle B,as it has more
quantity of both the goods. Hence indifference curves cannot intersect
each other.

.
CONSUMER’S EQUILIBRIUM USING IC APPROACH (HICKSIAN ANALYSIS):

Consumer’s equilibrium is a situation which is attained when the consumer gets

maximum satisfaction. It can be explained with the help of indifference curve
approach. According to this approach, if a consumer wants to be in the equilibrium
then the following two conditions must fulfilled:

1. Budget line should be tangent to the indifference curve

i.e. Slope of IC (MRS) = Slope of budget line (Px / Py)
𝑃𝗑
𝑀𝑹𝑺 = 𝑃𝑦
The first condition for the consumer’s equilibrium is that budget line should b
tangent to the indifference curve. As you can see in the figure below, that at Bundle‘k’,
there is tangency of budget line and the IC.

When MRS is not equal to Price ratio?

Say,
This implies that consumer will prefer more of good X then Y, since he is getting more utility
from X then
Y. As a result he will transfer his expenditure from Y to X. This leads to increase
in the consumption of X and fall in the consumption of Y. Further according to law
of diminishing marginal utility, marginal utility of X will fall and marginal utility
of Y will rise. This act of transfer will continue till MRS become equals to price
ratio and consumer attain equilibrium.
𝑃𝗑
𝑀𝑹𝑺 < 𝑃𝑦

This implies that consumer will prefer more of Y then X, since he is getting more
utility from Y than X. As a result he will transfer his expenditure from X to Y. This
leads to increase in the consumption of Y and fall in the consumption of X. Further
according to law of diminishing marginal utility, marginal utility of Y will fall and
marginal utility of X will rise. This act of transfer will continue till MRS become
equals to price ratio and consumer attains equilibrium.

2. IC should be convex to the point of origin :

The second essential condition is that at the point of equilibrium, IC should
be convex to the origin. As you can see in the figure below IC is convex to
 the origin at the tangency point between the given budget line and
indifference curve. This condition implies that MRS should be
diminishing at the point of equilibrium.

In this figure, on X-axis good X is taken and on Y-axis good Y is taken. IC1 is the
indifference curve which shows two bundles k and k1 providing same level of utility. These
two combinations can be achieved by the consumer because they are within the purchasing
power of the consumer. IC2 is another indifference curve which is tangent to the budget line
AB at point k2. The consumer can shift himself from IC1 to IC2, because at IC2 he gets more
level of satisfaction. Now, there is an another indifference curve IC 3, but it is beyond the
purchasing power of the consumer. So k2 is the combination at which consumer gets
maximum satisfaction. Where consumer is consuming OY’ quantity of good Y and OX’
quantity of good X.
VERY SHORT ANSWER TYPE QUESTIONS:

1. Find out TU for each unit of consumption of good X :

Units 1 2 3 4 5
MUx 10 9 7 3 -5

2. (a) A consumer has the income of Rs.200. Price of good X and good Y
is Rs.2 & Rs.5. Plot thebudget of the consumer.
(b) If the income of the consumer is Rs.24 and the price of good X &
good Y is Rs.4 & Rs.2.Answer the following questions:
(i) Can the consumer afford the bundle of 4X & 5Y? Give reason also.
(ii) What will be the MRSXY when the consumer is in equilibrium?
3. What do you mean by utility?
4. State the condition of law of equi-marginal utility. ( MUx / Px = MUy / Py )
5. What will you say about MU when TU is maximum? (MU is zero)
6. What is the reason behind a convex indifference curve? (Diminishing MRS)
7. What is the slope of budget line? (Px / Py)
8. State the condition of equilibrium when consumer consumes only one good.
9. What is law of diminishing marginal utility?
10. Define indifference map.
11. Define monotonic preference.

SHORT ANSWER TYPE QUESTIONS:

1. Explain the law of diminishing marginal utility with the help of utility schedule.
2. Explain the consumer’s equilibrium with utility approach in case of single good.
3. What do you mean by budget line? What are the reasons of change in budget line?
4. Explain the relationship between total utility and marginal utility with the help of
schedule.
5. Why does higher indifference curve gives higher satisfaction?
6. Why does indifference curves do not intersect with each other?
7. Define marginal rate of substitution. Explain why is an indifference curve convex?
8. A consumer consumes only two goods ‘X & Y’, state and explain the conditions of
Consumer’s equilibrium with the help of utility analysis.

LONG ANSWER TYPE QUESTIONS:

1. Explain the conditions of consumer’s equilibrium with the help indifference curve.
2. Explain the properties of indifference curve.
 HOTS:
1. What will be the behavior of TU when MU curve lies below X-axis?
2. Why should the budget line be tangent to the indifference curve at the point of
consumer’s equilibrium?
3. Why does consumer stop consumption in case where MU is less then price of a good?
4. What is budget line? Why it is negatively sloped?
5. Explain the conditions determining how many units of a good the
consumer will buy at a given price?
6. Rahul consumes two commodities X and Y whose prices are Rs.8
and Rs.12 per unit. He is in a state of equilibrium (utility
analysis) when MUx=3 and MUy=2, then according to the utility
analysis approach Rahul strikes his equilibrium?
Ans.
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7. Navya consumes Pizza and Coke and finds her equilibrium. If
the price of coke rises, how will it affects the state and
equilibrium? Explain its recovery.
Ans.
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8. A consumer is consuming two goods (Good X and Good Y)
where price of good X is Rs. 3 and Price of Good Y is also
Rs.3. On the other hand the MRS is 3. State whether the
consumer is in equilibrium or not.
Ans.
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9. Explain the meaning of diminishing marginal rate of
substitution with the help of numericalexample.
Ans.
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10. As consumer consumes only two goods X and Y whose prices
are Rs.4 and Rs.5 per unit respectively. If the consumer chooses a combination of two goods with
marginal utility of X equals to5 and that of Y equals to 4, is the consumer in equilibrium?Give
reasons. What will a rational consumer do in this situation? Use utility analysis.
Ans.
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11.A consumer consumes only two goods X and Y. The marginal
utility of X and of Y is 3. Prices of X and Y are Rs.2 and Rs.1. Is
the consumer in equilibrium? What will be the further reaction of
theconsumer? Give reasons.
Ans.
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ROUGH WORK
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