CONSUMER'S EQUILIBRIUM

LEARNINGOBJECTIVES
2.1 INTRODUCTION
2.2 CARDINAL UTILITY APPROACH
2.3 CONCEPT OF UTILITY
2.4 LAW OF DIMINISHING MARGINAL UTILITY
2.5 CONSUMER'S EQUILIBRIUM
2.6 ORDINAL UTILITY APPROACH (INDIFFERENCE CURVE ANALYSIS)
2.7 BUDGET LINE
2.8 CONSUMER'S EQUILIBRIUMBY INDIFFERENCE CURVE ANALYSIS
2.9 SOLVED PRACTICALS

2.1 INTRODUCTION
A consumer is the main decision-maker of consumption pattern. A consumer is one who buys
goodsand servicesfor satisfaction of wants. He takes decisions with regard to the kind of goods
to be purchased in order to satisfy his wants.The main objective is to get maximum satisfaction
fromspending his income on various goods and services.
Theaim of this chapter is to make you understand: How does a consumer maximize his satisfaction from
consumptionofgoodsand services.As the resources are limited in relation to unlimited wants, a
consumerhas to follow some principles or laws in order to attain the highest satisfaction level.
Thetwo main approaches to study consumer's behaviour and consumer's equilibrium are:
1. Cardinal Utility Approach (or Marshall's Utility Analysis or Marginal Utility Analysis)
2. Ordinal Utility Approach (or Indifference Curve Analysis)
2.2 CARDINAL UTILITY APPROACH
Peopleconsume different goods and services in order to maximise the satisfactionlevel.
However,to do this, it is necessary to determine quantum of satisfaction obtained from a
Particularcommodity. Under the Cardinal Utility Approach, the concept oeyti!iW_' is used
to attain

2.3 CONCEPT OF UTILITY

Althoughthe concept of 'taste' and 'satisfaction' are familiar for all of us, it is much more
difficultto express these concepts in concrete terms. For example;suppose you have just eaten
2.1
 Introductory Microeco
2.2 nothics
satisfied from each of th
an ice-cream and a chocolate.Can you tell how much are you
very difficult to express „h
is
items? Probably you can tell which item you liked more. But, it
more quantitative measure
much" you liked one over the other. It is evident, that we need a
utility.
of
satisfaction. Due to this reason, economists developed the concept
Of

Meaning of Utility
actual or expected
utility refers to want satisfyingpower of a commodity.It is the satisfaction,
person-to-person, place_to.
derived from the consumption of a commodity. Utility differs from
place and time-to-time. In the words of Prof "Utility is the ability of a good to satisfy
a want".
that the commodity
In short, when a commodity is capable ofsatisfying human wants, we can conclude
has utility.

How to Measure Utility?

According
After understanding the meaning ofutility, the next big question is: How to measure utility?
to classical economists, utility can be measured, in the same way, as weight or height is measured.
For this, economists assumed that utility can be measured in cardinal (numerical) terms. By
using cardinal measure of utility, it is possible to numerically estimate utility, which a person
derives froiif€6Å'üR1+G6RÖfS6öds and services. But, there was no standard unit for measuring
utility. So, the economists derived an imaginary measure, known as 'Util'
utils are imaginary and psychologicalunits which are used to measure satisfaction (utility) obtained
from consumption of a certain quantity ofa commodity.
Example - Measurement of satisfaction in utils
Suppose you have just eaten an ice-cream and a chocolate. You agree to assign 20 utils as utility
derived from the ice-cream. Now the question is: how many utils be assigned to the chocolate?
If you liked the chocolate less, then you may assign utils less than 20. However, if you liked it
more, you would give it a number greater than 20. Suppose, you assign 10 utils to the chocolate,
then it can be concluded that you liked the ice-cream twice as much as you liked the chocolate.
One more way to measure utility
Utils cannot be taken as a standard unit for measurement as it will vary from individual to
individual. Hence, several economists including Marshall, suggested the measurement of utility
in monetary terms. It means, utility can be measured in terms of money or price, which the consumer
is willing to pay.
In the above example, suppose 1 util is assumed to be equal to 1. Now, an ice-cream will yield
utility worth 20 (as 1 util = 1) and chocolate will give utility of 10. This utility of e 20from
the ice-cream or I()from the chocolateis termed as value of utility in terms of money.
The advantage of using monetary values instead of utils is that it allows easy comparison
between utility and price paid, since both are in the same units.
Consumer's Equilibrium 2.3

ltmust be noted that it is impossible to measure satisfaction ofa person as it is inherent to the individual
and differs greatly from person-to-person. Still, the concept of utilityis very usefu/ in explaining and
understanding the behaviour of consumer.

Explore More about Utility

Do not get confused with the dictionary rneaning of utility
The dictionary meaning of utilityis given as usefulness. However, to an economist, higher
utilitydoes not mean greater usefulness. A commodity may not be useful, yet it may have
utilityfor a particular person. For example, liquor is considered to be harmful for health, yet
it may have a high degree of utilityfor an alcoholic.
2. Satisfaction Vs Pleasure
Satisfaction must not be confused with pleasure. In fact, satisfaction need not involve
actual pleasure. For example, treatment of a patient for his broken arm is a source of great
satisfaction for the patient. However, it does not provide him any pleasure as it is merely
a relief from pain.
3. Utilityis Subjective
Utility varies from person to person. For example, a thirsty person derives more utilityfrom
water in comparison to a person who is not thirsty.

To properly understand the meaning of utility,it is necessary to discuss two of its very important
concepts: (i) Total Utility and Marginal Utility; (ii) Law of Diminishing Marginal Utility.

Total Utility (TU)

Totalutility refers to the total satisfaction obtainedfrom the consumptionof all possible
units of a commodity. It measures the total satisfaction obtained from consumption of all the
units of that good.
Forexample,if the 1stice-cream gives you a satisfaction of 20 utils and 2ndone gives 16 utils,
then TU from 2 ice-creams is 20 + 16 = 36 utils. If the 3rd ice-cream generates satisfaction of
10utils, then TU from 3 ice-creams will be 20 + 16 + 10 = 46 utils.
TU can be calculated as:
TUn= UI + + + n
Where:
TUn = Total utility from n units of a given commodity
— Utility from the 1st, 2nd 3rd n th unit
n = Number of units consumed

Do Consider it
1. The utilityderived from the first unit of a commodity is known as initial utility.For example:
Utilityof 20 utils from the first ice-cream is termed as the initial utility.
2. Total utilityis zero at zero level of consumption.

Marginal Utility (MU)

Marginalutility is the additional utility derivedfrom the consumption of one more unit of the
given commodity. It is the utility derived from the last unit of a commodity purchased.
 Introductory Microeconomics
2.4
36 utils to 46 utils,
As per given example, when 3rdice-cream is consumed, TU increases from
Chapman, "Marginal
The additional 10 utils from the 3rd ice-cream is the MUSIn the words of
commodity"
utility is addition made to total utility by consuming one more unit of a
as: MUn=TU -TUn_1
unit; TUn = Total utility from n units;
Where: MUn = Marginal utilityfrom nth
n = Number of units of consumption
TIJn_ = Total utilityfrom n - 1 units;
Mu will = TU3-TU2 = 46-36 = 10 utils
OlmeStore way to Calculate MU
change in units
MU is the change in TU when one more unit is consumed. However, when
consumed is more than one, then MU can also be calculated as:
Change in Total Utility ATU
SIU =
Change in number of units AQ
Total Utilitv is Summa tion of Marginal Utilities
i.e.
Total utility can also be calculated as the sum of marginal utilities from all units,
+ MUn or simply, MaximumTU
EMU b 50
The concepts of TU and MU can be better understood • 2 40
from the following schedule and diagram: 30
Table 2.1: TU and MU 20

Ice-creams Marginal Utility Total Utility 310

Consumed (MU)
6
x
20.
2 36 Units of Ice Cream
3 10 46
20
4 4 50
50 2 16
5 o
44 12
6
8
In Fig. 2.1, units of ice-cream, are shown along the 4
zero MU
X-axis and TU and MU are measured albng the
Y-axis. MU is positive and TU is increasing till the 4
th
O 123 4 x

ice-cream. After consuming the 5th ice-cream, MU is Units of Ice Cream

MU Curve
zero and TU is maximum. Thispoint is knownas the
point of satiety or the stage oftnaximum satisfaction. After Fig. 2.1*
consuming the 6thice-cream, MU is negative (known
as disutility) and total utility starts diminishing.
to consumption of too much Of
Disutility is theopposite It refers to loss of satisfaction due
of utility,

athing.
Consumer S Equilibrium
2.5
Explore More about Marginal Utility
I. Positive Marginal Utility: If total utility
increases from consumption of additional units
of a commodity, then marginal utilitiesof these units
will be positive.
2, Zero Marginal Utility: If the consumption
of an additional unit of a commodity causes
no change in the total utility,
then marginal utility of the additional
level of consumption, unit is zero. At this
total utilityis at its maximum.This point is
point of satiety or the point of also known as the
maximum satisfaction.
3. Negative Marginal Utility: If the consumption
of an additional unit of a commodity
causes a fall in the total utility, it means
that the marginal utility of that unit isinegative.
Negative utilityis also knownas disutility.

lationship between TU and MU

Table 2.1 and Fig. 2.1 shows the following points of
relationship:
1. (k! increases with an increase in consumption
of a commodity as long as MU is positive, i.e.
till
the 4th ice-cream. In this phase, TU increases, but a
diminishing rate as MU from each
successiveunit tends to diminish.
2. When TU reaches its maximum, MU becomes
zero, i.e. when 5thice-cream is consumed. This
is known as point of satiety. TU curve stops rising at this stage.
3. When consumption is increased beyond the point of satiety, TU starts falling as MU becomes
negative.
For Practical Problems of TU and MU,refer Examples 1 to 3 (Section 2.9) and 4 Unsolved Problems
givenin the Exercise.

2.4 LAW OF DIMINISHING MARGINAL UTILITY

aw of diminishing marginal utility (DMtI) states that as we consume more and more units
a commodity, the utility derived from each successive unit goes on decreasing))
In making choices, most people spread their incomes over different kinds of goods. People
prefera variety of goods because consumingmore and more of any one good reduces the
marginalsatisfaction derived from further consumption of the same good. This law expresses
an important relationship between utility and the quantity consumed of a commodity. Let us
understand this law with the help of an example:
Suppose your father hasjust come from workand you offer him a glass ofjuice. The first glass ofjuice
willgive him great satisfaction. The satisfaction with the second glass of juice will be relatively lesser.
Withfurther consumption, a stage willcome, when he would not need any more glass of juice, i.e.
When the marginal utility drops to zero. After that point, if he is forced to consume even one more glass
Ofjuice,it willlead to disutility,Such a decrease in satisfaction with consumption of successive
units occurs due to 'Law of diminishing marginal utility'.
LawOfDMU has universal applicability and applies to all goods and services. This law was
firstgiven by a German economist H.H. Gossen. That is why, it is also known as 'Gossenßfirst
law of consumption' ,
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 2.7
Consumer's Equilibrium
Diagrammatic Explanation of Law of DMU
Let us understand the law with the help of Table 2.2 and Fig. 2.2:
Table 2.2: Law of Diminishing Marginal Utility
Units of Ice Cream Total Utility(in utils) Marginal Utility(in uti13)
20 20
2 36 16
3 46 10
4 50 4
5 50 O (Point of Satiety)
6 44
re
In the diagram, units of ice-cream are shown Y Law of Diminishing Marginal Utility
along the X-axis and MU along the Y-axis. MU
(e, fromeach successive ice-cream is represented
20
by points A, B, C, D and E. MU Curve slopes downwards,
indicating decrease in satisfaction
As seen, the rectangles (showing each level 16
witheach gucceggive ice cream
of satisfaction)become smaller and smaller 12
with increasein consumption of ice-creams. c
st MU falls from 20 to 16 and then to 10 utils, D Zero MU(Point of Satiety)
when consumption is increased from 1st to 2nd
and then to 3rd ice-cream. 5th ice-cream has no
o 1 2 6
utility (MU= O)and this is known as the 'Point Negative MI.J
—4 Units of Ice Cream
of satiety'. When 6th ice-cream is consumed,
MUbecomes negative. MU curve slopes -8 MU

downwardsshowing that MU of successive Fig. 2.2

units is falling.
Explore More about Law of DMU
1. MU may increase initially
In certain situations, MU may increase. For example, a thirsty person may be more satisfied
with the 2ndglass of water as compared to the 1st one. It all depends on the circumstances.
But, economists normally assume that MU continuously falls.
2. No indication about the rate of fall in MU
Law of DMU says nothing about the rate of decline of MU. It does not specify whether MU
falls at a slow or a fast rate or whether it declines at a uniform or a variable rate. It just states
that MU falls with increase in the consumption of a given commodity.
3. Synonyms of Law of DMU
It is also known as the 'Fundamental Law of Satisfaction' or 'Fundamental Psychological Law'.

2.5 CONSUMER'S EQUILIBRIUM

The term 'equilibrium' is frequently used in economic analysis. E uilibrium means a state ofrest
ora positionofno change.It refers to a position of rest, which provides the maximum benefit or
gainunder a given si tion. A consumer is said to be in equilibrium, whenhe does not intend
to change his level of consumption, i.e., when he derives maximum satisfaction.
 2.8
Introductory
Olicro
Consumer's Equilibriutn consunter is having
to the situation when a
trith lintited
ineot'te and has tendency to change his way of existing expenditure) f
The consumer commodity. so, he cannot Qct' Const
has to pay a price for each unit of the buy or
unlimited quantity. As per the Law of I)MU, utility derived from each successive
unit •
decreasing. At the same time, his income also decreases with purchase of more and goes
Sil
Of a /lis expenditure in such a manner more
so, a rational consutner aitns to balance co
gets
satisfaction with expenditure. When he does so, he is said to be in equilib
Not
After reaching the further incentive to make any change
point of equilibrium, there is no equ
quantity of the commodity purchased. in bea
different situations: be
Consumer's equilibrium can be discussed under two
1. surncr spends his entire income on a Single Cotnmodity Let
Consumer spends his entire income on Two Commodities on si

umer's Equilibrium in case of Single Commodity utils

1 util
Law of DMU can be used to explain consumer's equilibrium in case of a single
Therefore, all the assumptions of Law of DMUare taken as assumptions of consume;
equilibrium in case of single commodity.
A consumer purchasing a single commodity will be at equilibrium, when he is buying such a
of that commodity, which gives him maximumsatisfaction.The number of units to be
the given commodity by a consumerdependson 2 factors:
-d.¯frrice of the given commodity;
2. Expected utility (Marginal utility) from each successiveunit.
e To determine the equilibrium point, consume comparesthe price (or cost) of the give
commodity with its utility (satisfaction or benefit) einga rational consumer, he will beat equilibrilt
when marginal utility is equal to price paid for the commodity.)
indi
We know, marginal utility is expressedin utils and price is expressed in terms of monev succ
However, marginal utility and price can be effectivelycompared only when both are stated to o
the same units. Therefore, marginal utility in utils is expressedin terms of money. hori
fixe
Marginal Utility in utils
Marginal Utility in terms of Money = Fro
Marginal Utility of one rupee (MUM)
that
clone rupee is the extra utility obtained when an additional rupee is spent on other goods. As utilit whe
is a subjective concept and differs from person to person, it is assumed that a consumer himse at p
defines the MU of one rupee, in terms of satisfactionfrom bundle of goods.
4
_..iüt•
• Equilibrium Condition
Consumer in consumption of single commodity (say, x) will be at equilibrium when:
Marginal Utility (Mllx) is equal to Price (PX)paid for the commodity; i.e. Mll = Price
JfMlIx > then consumer is not at equilibrium and he goes on buying because benefiÜ
greater than cost, As he buys more, MU falls because of operation of the law of diminishin
 2.9
Oonsumer's Equilibrium
marginal utility. When MU becomes equal to price, consumer gets the maximum benefits
and is in equilibrium.
similarly, when MCIx < Pa.,then also consumer is not at equ ilibrium as he will have Coreeloce
consumption of commodity x to raise his total satisfaction till MU becomes equal to price,
Note: In addition to condition of "MU= Price", one more condition is needed to attain consumor'$
equilibrium:'MU falls as consumption increases". However, this second condition is always implied
vecaUSeof operation of Law of DMV. So, a consumer in consumption of single commodity will
be at equilibrium when MU= Price.
Letus now determine the consumer's equilibrium if the consumer spends his entire income
on single commodity. Suppose, the consumer wants to 'buy a good (say, x), which is priced
at 10 er unit. Further suppose that marginal utility derived from each successiveunit (in
utilsand in e) is determined and is given in Tåble 2.3 (For sakeof sijnplicity,it is assunteclthat
1, i.e. MUM = 1).
1 util
Table 2.3: Consumer's Equilibrium in case of Single Commodity
Price (PO Marginal Marginal utility Difference Remarks
Units of
x utility (utils) (MUD MUx and PX

MUx > PX, SO

1 10 20 20+1- 20 20-10= 10 consumer will increase
10 16 16+1= 16 16-10= 6 the conumption
Consumer's
3 10 10 10+1= 10 10-10= Equilibrium (MU = PX)
4 10 4 4 4 MUx < PX, so
10 o 0-10 = -10 consumer will decrease
5
-6 -6+1- -6-10= 16 the consumption
6 10

In Fig. 2.3, MI-Jxcurve slopes downwards, Consumer Equilibrium in case

of Single Commodity (x)
indicatingthat the marginal utility falls with
successiveconsumption of commodity x due X 20
to operationof Law of DMU. Price (PX)is a
E 16
horizontaland straight price line as price is Consumer Equilibrium (MUx= PX)
fixedat 10 per unit. ? 12 PIC
o

Fromthe given schedule and diagram, it is clear

that the consumer will beat equilibrium at point 'E', Zero MU (Point of Satiety)

whenhe consumes 3 units of commodity x, because

6
at point E, Mllx = PX o 1 2 3 4
Units of commodityx
He will not consume 4 units of x as MU of —4
MUk
4 is less than price paid of 10. -8
• Similarly, he will not consume 2 units of x as Fig. 2.3
Mb of 16 is more than the price paid.
 Fe in of single commodity (say, x) trill be
the cerrrtodity (.MLI%) is to price (PX)

refer ExampC€s4 to
efCcrs:.jne6s Eguii&iumIncase ctSagIe
in he Exsccåse.

However,
EFLies E'.ese of either one or one use of a commodity

a than one commodity. In such a situation, 'Laze

allocation of his

uciil•yssse as: (l) Law of Subsåtutcn; (ii) Law ofmaxjmum satisfaction;

As QE u€litv is Yased on Law of DMV, all assumptions of the latter also

Let us now-discuss oQonsumer by taking two goods: 'x'

sane an.alvsiscan be extended for any number of goods. In case of consumer
commodity, we assumed thatthe entireincome was spent on a single
censure his money income between the two •oods to
wants to allocate
the positioru

cf a sets satisfaction, ratiosof

R.å tite+ r—ectice prices as consumption increasesv
E mez•s, there are two necessary conditions to attain Consumer's Equilibrium in case
of Two Commodities:
Utility to Price is same in case of both the goods.
of single commodity (say, x) is at equilibrium

• vsillbeatequilibriumwhen

ERuaEngt and 2, we get: —MU

As utility of money (MUM)is assumed to be

constant, the above equilibrium
 2.11

What not equal to

(ec¯$uppose, n this case, the consumer is getting more marginal

utilityper rupee in case of good X as compared to Y, Thorefore, he will buy more of
X and less of Y This will load to fall in MUK and rise in MUY.The consumer will
MU
continuo to buy more of X titl MUE
y)
MU MU
When < , the consumer is getting more marginal utilityper rupee in case

q of good Y as compared to X. Thoreforo, ho will buy more of Y and less of X. This will
lead to tall in MUY and riso in MUx. The consumer will continue to buy more of Y

It brings us to a conclusion that is a necessary condition to attain Consumer's

Equilibrium,

(ii) Mtlfall$ as consumption increases:The second condition needed to attain consumer's

equilibrium is that MU of a commodity must fall as more of it is consumed. If MU does
not fall as consumption increases,the consumerwill end up buying only one good
which is unrealistic and consumer will never reach the equilibrium position.
Finally,it can be concluded that a consumer in consumption of two commodities will be at
equilibriumwhen he spends his li Ited income in such a way that the ratios of marginal utilities
oftwocommodities and their respective prices are equal and MCIfalls as consumption increases.
Explanationwith the help of an Example
Letus now discuss the law of equimarginalutility with the help of a numerical example.
Suppose,total money income of the consumer is 5, which he wishes to spend on
twocommodities:'x' and Both these commodities are priced at 1 per unit. So,
consumercan buy maximum5 units of 'x' or 5 units of 'y'. In Table 2.4, we have shown
themarginalutility which the consumer derives frotålvarious units of 'x' and 'y'.
Table 2.4: Consumer's Equilibrium in case of Two Commodities
IJnits MU of commodity 'x' (in utils) MU ofcommodity'y' utils)
(in
20 16

2 14 12
3 12 8
4 7 5
5 5 3
0" , 切00~
0「
。 「丶
which

Which hhowt4 the

Tiiblo 2.6: Indifforonco $chodujo
Combination ot (A) (IJ)
f/(j/q
Ap and Bananas

As seen in the schedule, connumer iBindifferent

betweenfive combinationsof apple and o 1 4
Combination'P' (IA + 15B) giveti the utiJity
as (2A 10B),(3A 6B) and on, When 24
combinationsare repregcnted graphically and
/
joinedtogether, we get an indifference curve jCj'
as shown in Fig. 2.4.
In the diagram, apples are measured along the X-axif'and banana* on the Y-azi%, point%(P,
Q, R,S and T) on the curve show different combinations of appl et' and banarvj%, point"
arejoinedwith the help of a smooth curve, known indifferenct:curve (JCj),hr/ indifference
curveis the locus of all the points, reprew/lling different combinationø, that are equally oati%fuctoryto
the consumer.
Everypoint on ICJ, represents an equal amount of gatj%factionto the conourncr, 9), the
is said to be indifferent between the combinations Jocated on 'IndifferenceCurve 'ICJ',
'Tho combinations P, O, R, S and Tgive equal satisfaction to the conournorand thercforo ho ig indifferent
gmong them.Thogecombinations are together knownas 'IndifferenceSott
MonotonicPreferences
Monotonicpreferencemeans that a rational consumer always prefers more of a commodity
it Offershim a higher level of satisfaction, Jn simpJe word", monotonicpreferencesimpliesthat
consumptionincreasestotal utility also increases.For instance, a consumer/%preference, are
monotoniconly when between any two bundles, he prefers the bundle which has more (Jfat
jeastone of the goods and no Jess of the other good as compared to the other bundle,
 tre.%ductan/

Exarg•lc Ccnsider 2 goads: Apples (A) and Bananas

(7A, 7B).
T: (IOA„
as compared to 2nd bundle will be
Cct•suzer's of butdle called
apples and bananas.
as bzmdle art-airs more of both

preference of b';andleas compared to 2Cdbundle T,vill be called

are same.
as contains more of apples, although bananas

represent
Map 'Efas to tiæfamily ofi%diffæzce curves that
the bazålz•s cf the two goods.
An represens all combinaåons, which Indifference Map

les-el cf saEsås:Ecn- However, every higher

lower of satisfactioncan be on different
Itnears, t'..änite of indifference

2.3, ICI åhelowest satisfaction„IC2 shows

than hat cf ICI and d-tehighest level of ict

sa±s.fazticn depictedby cur.-eICY However,

c.
eas czn-e same level of saäsfaction o R s
CammcCityX
Fig. 2.5

berctZ curves r%tæent higher levels of satisfaction'as

of goods, wtich means mote uåli?ybecause

3 Subsection (MRS)
SIRS rzfzrs to the rate at ukich the commoditiescan be substituted with each other,so tm:
satisfacticz cftkz coaszmeræmaia.s the sam5cr in the example of apples (A

of that the consumeris

fæ additior=l zmit of so as to maintain he same level of satisfaction.

Erzrzs (B) willing to Sacrifice

of Apples (A) wüing to Gain

is rate at which a ccnsumaÉ wüling to give up Bananas for one more tOf
the indifferencecurve.
Rnstbe i' LiÆstuÆa%ays beægaåveas numerat0C t
absoååte value of MRS is
 2.15
2.6and 26.

VPS betweenApple and Banana

Appies Sanaoa (B) MRS

2
3
s 3
23 IA
VPS betweenApple and Banana

153) is convex shaped due

to diminishing MRS
12
103)

3 S 3B)

1 23 Appes
Fig.

s±xaå-cle and consumer moves from P to Q, he sacrifices

BCRSA3 comes out to be 5:1- Similarly, from Q to R, MRSAB is 4:1.
T, sacrifice fans 2 bananas for 1 apple. In other words, the .N4RS of apples

YES Zzz• In the given example of apples and

7 has 1 apple arid*eerefore, apple is relativelymore important
{o is willing to eve up more bananas for an addi€onal
and more of apples, his margi.nal uålity from apples keeps on
up less and less of bananas for each apple.
ee<z one
z lways SD-the originzAn indifference curve is convex to
bzarse M.E.MRS'dedines continuously becauseof the law of
L.aEty. As Table 26, when tie consumer consumes more and
z:zgnaJ from apples keeps on declining and he is willing to give
cfbaraarzs apple. Therefore, indifference curves are convex to the
E be MRS indicates the slope of indifferencecurve.
 Introductory
2.16
a consumer consumes
It implies that as
Indifference curve slope downwards: because if the consume
the other good. Ithappens d
good, he must consume lessof reduce the number
apples), he will have to
to have more units of one good (say
total utilty remains the same.
a other good (say bananas), so that
ofsatisfaction: Higher indifferenG
. Eligher Indifference curves representhigherievels
which means more utility because of monotonic
represents large bundle of goods, consumer gets the
At 'A',
IQ in Fig. 25
Consider point 'A' on ICJ and point 'B'on
X and Y. At VB',consumer gets the combination (Of,
(OR, OP) of the two commodities
IQ.
s OS > OR, the consumer gets more satisfaction at
x. . Indifference curves can never intersecteach
other: As two indifference curves cannot represent
the same level of satisfaction, they cannot intersect
hdifference Ce
each other. It means, only one indifference curve {Cz can never
each other
will pass through a given point on an indifference
map. In Fig. 2.7,satisfactionfrom point A and from
B on ICI will be the same. Similarly, points A and
C on IC2 also give the same level of satisfaction. It
means, points B and C should also give the same
level of satisfaction. However, this is not possible,
as B and C lie on two different indifferencecurves, Fig. 2.7
ICI and IC2 respectively and represent different
levels of satisfaction. Therefore, Ovoindifference
curves cannot intersect each other.

mptions of indifference Curve

various assumptions of indifference curve are:
lezTwo commodities: It is assumed that the consumer
has a fixed amount of monetf%
which is to be spent on the two goods, given
constant prices of both the goods.
.24 Non Satiety: It is assumed that the consumer
Consumer
has not reached the point of
always prefer more of both commodities,
i.e.he always
indifference curve to get higher and higher tries to move to a
satisfactiorc
3. Ordinal Utili9t
Consumercanrankhispreferenceson
the basis of the satisfaction
CDiminishingmargina1rateofsubstitution:
marginal rate Due to this assumption,
an indifference curve is convex
51 Consumer The consumer
is assumed to
behave in a
i-e•he
2.7 BUDGET LINE
we discussed oc that
satisfaction.But, which will a aeiualty
income('consumer and prices of the states the
or purchasing of the tri;icit he cettaitt titat
pi-ice.It means, a cÄ)nsVitnet'
can putvhase only those (thitnlle,q)
ofgoodsjwhich cost less than OtsR-yualto his ineotne,
line is a graphical reptvscntatiott of all possible
cootbittatiotts tteo goods ich catt
purchasedwith sieen ineomc prices, such that the cost ot each titese cotttl'ittatiotts
is equal to the money incotnc of the cotiStotter.Alternately, Budget
låttc is locus
combinationsof the two goods which the eonstattes and ü'hich cost exactli/ his itteottte,
Letus understand the concept of Budget line with the help of an exatnple:
suppose,a consumer has an income of 20. le wants to spend it on two conunodities:N and
Yand both are priced at 10 each. Now, the consumer has three options to spend his entire
income:(i) Buy2 units OfX; (ii) Buy 2 units of Y; or (iii) Buy I unit OfX and 'l unit of Y. It means,
possiblebundles can be: (2, 0); (0, 2) or (1, 1).
Whotalithese three bundles are representedsraphically, avget a dotonteard sloping straight line, knoa tn
as 'BudgetLine'. It is also known as priceüine.
BudgetSet
Budgetsetis the setofallpossible contbinations of the two goods which a consorter can afford,
givenhis inconte and prices in the market.
In additionto the three options, there are some more options available to the consumer within
his income,even if entire income is not spent. Budget set includes all the bundles with the
total income of 20, i.e. possible bundles or Constuner's bundles are: (0, 0); (0, 1); (0, 2); (1, 0);
(2,O);(IA). Consumer's Bundle is a quantitative contbination of troogoods rehich can be purchased by
a consumgr_frpnt11iSgicmincome.
BudgetLine Vs Budget Set
Budget Set and Budget Line are two distinct concepts.
(i) Budget set include all the possible bundles which cost less than or equal to
consumer's money income at the given prices. On the other hand, budget line
represents all those bundles that the consumer can purchase by spending his entire
income at the given prices.
(ii) The bundles of budget set lie either on or below the budget line. The bundles of
budget line lie only on the budget line.

DiagrammaticExplanation of Budget Line

Suppose,a consumer has a budget of 20 to be spent on two commodities:apples
(A)and bananas (B).If apple is priced at 4 each and banana at 2 each, then the consumer
candetermine the various combinations (bundles), which form the budget line. The possible
Optionsof spending income of 20 are given in Table 2.7;
 IntroductoryMicroeconomie

Table 2.7: Schedule of Budget Line

(R)
Combination of Apples Apples (A) Bananas (B) Money spent= Income
and Bananas (R4 each) • (R2 each)
(5 x 4) + (0 = 20
5 0
2
(4 x 4) + (2 x 2) = 20
4
4 (3 x 4) + (4 x 2) = 20
G 3
6 (2 x 4) + (6 x 2) = 20
2
8
10 (0 x 4) + (10 x 2) = 20

Budget Line
c
10 J Unattainable
Combination

2
Point 'D' indicates that
income is underspent
x
o 1 2 3 4
Apples (A)
Fig. 2.8

Fig. 28 number of apples are taken on the X-axis and bananas on the Y-axis. At one extreme
(Point CEO), consumer can buy 5 apples by spending his entire income of 20 only on apples.
The other extreme (Point 'J'), shows that the entire income is spent only on bananas. Between
E and J, Erre are other combinations like F, G, H and I. By joining all these points, we get a
s&aisht line known as the Budget Line or Price line.
cn this budget line indicates those bundles of apples and bananas, which the consumer can
F'zrcYzz€e
ty spending his entire income of e 20 at the given prices of goods.

Points abcut Budget line (Refer Fig. 2.8)

Budget EneAB slopes downwardsas more of one good can be
bought by decreasing
sane urns of Oter good.
Z Bundies wt±h cost exactiy equal to consumer's money
income (like combinations
E toJ) re be badgetline.
3. B',rdes ve+ichcost less than consumer's money income
(like combination D) shows
They fie inside the budget line.
B.n&es cost rnore than consumer's money income (like combination
C) are not
avaiab& to Äns.jrner.They lie outside the budget line.
Consumer's Equilibrium 2.19
Algebraic Expression of Budget Line.
Thebudget line can be expressed as an equation:

Where:
M = Money income;
QA = Quantity of apples (A);
QB = Quantity of bananas (B);
PA = Price of each apple;
PB = Price of each banana.
All points on the budget line 'AB' indicate those bundles, which cost exactly equal to 'M'.
AlgebraicExpression for Budget Set: The consumer can buy any bundle (A, B), such that:

Slope of the Budget Line

We know, the slope of a curve is calculated as a change in variable on the vertical or Y-axis
divided by change in variable on the horizontal or X-axis.In the example of apples and bananas,
slopeof the budget line will be number of units of bananas, that the consumer is willing to sacrificefor
an additional unit ofapple.
Units of Bananas (B)willing to Sacrifice AB
Slope of Budget Line =
Units of Apples (A) willing to Gain AA
As seen in Fig. 2.8, 2 bananas need to be sacrificed each time to gain 1 apple. So Slope of Budget Line
2
1 1
**Numeratorwill always have negative value as it shows number of units
to be sacrificed. However, for analysis, absolute value is always considered.
This slope of budget line is equal to 'Price Ratio' of two goods.
Price Ratio or Marginal Rate of Exchange (MRE)
Price Ratio is the price of the good on the horizontal or X-axis divided by the price of the good
on the vertical or Y-axis. For instance, If good X is plotted on the horizontal axis and good Y
Price ofX(Px) PX
on the vertical axis, then: Price Ratio =
Price of Y (PY)-py
Why slope of Budget Line is represented by Price Ratio?
A point on the budget line indicates a bundle which the consumer can purchase by spending
his entire income. So, if the consumer wants to have one more unit of good 1 (say, Apples or A),
bananas
then he will have to give up some amount of good 2 (say, Bananas or B). The number of
needed to be given up to gain 1 apple depends on the prices ofapples and bananas.
As per Table 2.7, Apple (A) is priced at 4 (PA)and Bananas (B) at 2 (PB).It means, to gain
I apple, consumer will have to reduce his expenditure on bananas by 4, i.e. consumer will
have to sacrifice 2 bananas to gain 1 apple. It means, consumer will have to give units of

Banana to gain one apple. -A is nothing but the price ratio between Apples and Bananas. So,
it is rightly said that Price Ratio indicates the slope of Budget Line.
 ra:e a,YS

it slopes
as some units of the other good.
a Tae slope of line is represehted by the
is line is a stnight line,

E-aeis +ae income of consumer and

A rew line would have to be drawn if either (a) Income
cr (b) of mmmodity changes
Let us this example ei apples and bananas:
1. Efi.+A±eE
a in oi Consumer If there is any change in the income,
change oi apples and bananas,then the budget line will shift.
ir•easæ, be able to buy more bundles of goods, which were
•not It will shift Fudget line to ffe right from to 'Al Bl as seen in Fig.
Te budget line KAIB:Cwill be parallel to the original budget line %AB'.
of Change in
on Budget Line

Rightward Shift: Budget Line shifts

be ti$tt fromAB toA,B1 due
to itcease in irmme
Leftward Shift: Budget Line shifts
to be Set tomAB toA2B2 due
b decrease in income

o x
Bogies (A)
Fig. 2.9

Similarly, a decrease in income Willlead to a leftward shift in the budget line to A2B2•
Why is the new Budget line paraltef to original budget line ?
The rewbudget 'A,Bt' or 'AA' is parallelto originalbudget line AB' because there
one
is ro change inthe slope-We know,the slope of a curve is calculated as a change in
•variablethat OCCUTSdue to change in anothervariable. In case Of budget line, slope the
+ P -As change in income does not disturb the price ratio of the two commodities, to
s:ope wig not change and the budget tine, after change in incomp will remain parallel
the original budget line,
 2. Effectof change in the relative Prices (Apples and Bananas): If there is any change in prices
of the two commodities, assuming no change in the money income consunwr, then budget
of
linewill change. it will change the slope of budget line, as price ratio will change, with change
in prices.
(i) Change in the price of commodity Chango in Price of Appt08
on X-axis (Apples): When the price
of apples falls, then new budget line
is represented by a shift in budget
• Budgot Lino shifts fromAB to AIB duo
line (see Fig. 2.10) to the right from to docroaso in prico of Apples
'AB' to 'Alb'. The new budget line • Budgot Lino shifts from AB to A2B duo
meets the Y-axisat the same point to increago in prico of Applog
because the price of bananas
has not changed. But it will touch o A2 A Al x
the X-axis to the right of 'A' at point Apples (A)
'Al because the consumer can now Fig. 2.10
purchase more apples, with the same income level. Similarly,a rise in the price of
apples will shift the budget line towards left from 'AB' to
(ii) Change in the price of commodity on Y-axis(Bananas):With a fall in the price of
bananas, the new budget line will shift to the right from 'AB' to 'ABI' (see Fig. 2.11).
The new budget line meets the X-axisat the same point 'A', due to no change in the
price of apples. But it will touch the Y-axis to the right of 'B' at point '131',because the
consumer can now purchase more bananas, with the same income level.
Change in Price of Bananas

• Budget Line shifts fromAB to ABI due

to decrease in price of Bananas
• Budget Line shifts from AB to AB2 due
to increase in price of Bananas

t. x
o
Apples (A)
Fig. 2.11
Similarly, a rise in the price of bananas will shift the budget line towards left from 'AB'
to 'AB2'.

2.8 CONSUMER'S EQUILIBRIUM BY INDIFFERENCE CURVE ANALYSIS

onsumer equilibrium refers to a situation, in which a consumer derives maximum satisfaction,
with no intention to change it and subject to given prices and his given income. Thepoint of
maximumsatisfaction is achieved by studying indifference map and budget line together.QJ
 the possibl
to
'io his budget const.Tåiat,

e theory the following

be and Y.The condition is that MFSXY

consumer is wiJJjng to
that to obtain one more unit of X , the
the
compared 10 is required in the market, It jnd aces
becomes
to a result, MRSfalls and confinue fo fall till it
oi prices and the equilibrium is established.
.iixneartEthat to obtain one more mil of X , the consumer is willing to

satxifce units as compared to is required in the market. It induces the

to buy more of Y.As a result; MRS rises till it becomes equal to
Tatio FiGäÜi%Üequiiibrium is established
falls. The second condition for consumer's equilibrium is that MRS
at thepoini of equilibrium, i.e. the indifference curve must be con vex
at point 01equilibrium, Unless MRScontinuously falls, the equilibrium
egtah1ishedM
Titus, *beconåzticrnsneeå to befulfilledfor a consumer to Dein a equilibrium.
this mith the a diagram:
.Z.*t ICY ICCand ICs are the three Consumer'sEquilibriumby
and AB the budget line. y indifferenceCurve Approach
of line, fhehighest

tp indifference Consumer is at equilibrium at

Teis is the poi*f of Point E, wh€o budget line AE
is just tangent to '1%'
the consvmer
gazrz$iiyoleo—neodity and

line to the left or

"E' lowerindiffermce jcj
,gcuryes audiceiea lower level of x
line be l,ønsentio Cornrrtodity
X
Fig, 2.12
Cog.gurretS Equifibriumii 2.23
only otte indifference curve, consumer tnaxitnizes his satisfaction at point E, when both t/le
conditionsofconsumer's equilibrium are satisfied:

(i) MRS= Ratio of prices or -X : At tangency point E, the absolute value of the slope of
the indifference curve (MRSbetween X and Y) and that of the budget line (price ratio) are

same. Equilibrium cannot be established at any other point as MRSxy> at all point to

the left of point E and MRSxy< -X at all points to the right of point E. So, equilibrium is

established at point E, when MRS

(ii)MRScontinuously falls. The second condition is also satisfied at point E as MRSis

diminishing at point E, i.e. IC2is convex to the origin at point E.

CardinalUtility Vs Ordinal Utility

1. Undercardinal utility approach, it is assumed that utility can be measured in cardinal terms,
such as 1, 2, 3, etc. However, according to ordinal utility approach, utility is a subjective
concept,which cannot be measured and we can just rank the scale of preferences.
2, Undercardinal approach, the term "util" was developed as a unit to measure utility, whereas,
no such unit of measurement was developed under ordinal approach.
3. Example: Suppose a person consumes apple and banana.
• Accordingto cardinal approach, the consumer can assign utils to both the commodities,
say, 20 utils to apple and 15 utils to banana. It signifies that apple offers 5 more utils than
banana.
Accordingto ordinal approach, the consumer cannot express the satisfaction in exact
terms. It means, if the consumer likes apple more than banana, then he will give 1st rank
to apple and 2ndrank to banana.
2.9 SOLVED PRACTICALS
ImportantFormulae at a Glance
TU EMU
2. MUn
3. Consumer's Equilibrium in case of Single Commodity is attainedwhen
MU Price.
4. Congumer'a Equilibrium in case of TWOCommodities: (i) MU of last rupee spent
on each commodity is same, i.e. Or ; and (ii) MU falls as
consumption increases.
p x py MUy py