3 CONSUMER'S EQUILIBRIUM— ’ UTILITY ANALYSIS = Whoisa Consumer? Concept of Utility ™ Measurement of Utility: Cardinal and Ordinal Measurement ™ Concepts of Total Utility and Marginal Utility @ Law of Diminishing Marginal Utility ; 1 Concept of Consumer's Equilibrium 1 Marginal Utility Analysis and Consumer's Equilibrium The Basic Limitation of Utility Analysis ©1. WHO IS A CONSUMER? ienerally, a consumer is thought of as an individual but in practice consumers consist of itution: 5 id households) } Consumer behaviour refers to the way in which consumers spend » their income. The consumer derives utility from his expenditure. The consumer chooses his expenditures and maximises his utility with the given income and given prices of goods and services. 2. CONCEPT OF UTILITY Consumption of goods and services leads to satisfaction of human wants. You consume a cup of tea, and you get some satisfaction. This satisfaction is called ‘utility’, Thus, utility may be defined as ‘satisfaction derived from the consumption of @ commodity’. Or, it ns ‘ 473, MEASUREMENT OF UTILITY: CARDINAL AND ORDINAL MEASUREMENT Can we measure satisfaction (utility) in terms of some units? Two great economists (Alfred Marshall and J.R. Hicks) have different opinions. Marshall believes that we can measure satisfaction in terms of cardinal numbers, like 1, 2, 3, 4, etc. The standard unit of measurement used by Marshall to measure utility is called utils. Thus, when you consume a cup of tea, you can express your satisfaction as equal to 2 utils or 3 utils. This is called cardinal measurement of utility. Hicks, on the other hand, believes that satisfaction can only be ranked as ‘high’ or ‘low’; it cannot be expressed in terms of units (or utils). Thus, what you can say is that a cup of tea gives you greater satisfaction than a cup of coffee. You cannot say that a cup of tea gives you 3 units of utility and a cup of coffee gives you 2 units of utility. This is called ordinal measurement of utility. Cardinal measurement of utility means that utility (satisfaction) can be measured in terms of cardinal numbers or units like 1, 2 and 3. Ordinal measurement of utility means that utility (satisfaction) can only be ranked (high or low); it cannot be expressed in terms of units like 1, 2 and 3. The present chapter discusses consumer's equilibrium on the assumption of cardinal measurement of utility. tis called utility analysis of consumer's equilibrium. [The next chapter deals with consumer's ” equilibrium based on ordinal measurement of utility.] { { % 4. CONCEPTS OF TOTAL UTILITY « AND MARGINAL UTILITY Total Utility (TU): (It_is the sum total of utility derived from if consumption of all the units of a commodity. To illustrate, if 2 units of a commodity are consumed and 1st unit yields satisfaction of 10 utils, while the 2nd unit yields satisfaction of 9 utils, then total ci = 10 utils + 9 utils = 19 utils (or 19 units of utility) f ae Marginal Utility (MU): (t refers to additional utility on account of consumption_of an additional unit of a commodity. If 10 units fa commodity yield satisfaction of 100 utils, and 11 units of a corn need yield satisfaction of 105 utils, then additional utility on account of the consumption of 11th unit of the commodity is 105 - 100 = 5 si This is called marginal utility. Th — y. Thus, marginal utility (MU) is measured MU=TU, - TU,.,Referring to the above example MU =TU,,-TU,9 [Total utility from 11 units . - Total utility from 10 units) = 105 utils - 100 utils = 5 utils An Illustration on the Estimation of TU and MU Table 1 gives an illustration on the estimation of TU and MU Table 1. Estimation of TU and MU 100 (TU, ~ TU, = 100 -O= 100) 90 TU, ~TU, = 190-100 = 90} 80 (TU, ~ TU, = 270 - 190 = 80) 70 [TU,—TU, = 340 ~ 270 = 70) 60 (TU, TU, = 400-340 » 60) Table 1 shows : (i) MU, = TU, ~ TU-5 (i) TU = EMU = [100 + 90 + 80 + 70 + 60) = 400 Converting Table 1 into a diagram, we get the following picture : vg Total Utility Curve FIGUREUtility and Marginal Utility pee between Total of utility is explained with the help of ‘of these concepts ; Table 2 and Fig: 2 Table 2. Relation between Total Utility and Marginal Utility ora Marginal Utility |Table 2 offers the following observations on the relation between total utility and marginal utility: (i) As more and more units of a commodity are consumed, the marginal utility derived from each successive unit goes on diminishing. But the total utility increases upto a limit. (ii) Marginal utility of the first four units being positive, the total utility goes on increasing. Thus, as long as the marginal utility of the commodity remains positive, total utility goes on increasing. (iii) Marginal utility of the fifth unit is zero. In this situation, total utility (20) will be maximum, This situation represents point of saturation. Consequently, where marginal utility is zero, total utility is maximum. (iv) Marginal utility of the sixth unit is negative (-2). As a result of it, total utility of six units of the commodity falls from 20 to 18 units. In Fig. 2(A), TU curve represenits total utility. It slopes upwards upto point ‘G’, Point 'G' represents maximum total utility at the 5th unit. After point ‘G', TU slopes downwards, meaning thereby, that at the 6th unit, marginal utility becomes negative and total utility begins to decline. In Fig. 2(B), MU curve represents marginal utility. It slopes downwardsee 5, LAW OF DIMINISHING MARGINAL UTILITY <— Psychologically, intensity of desire for a commodity tends to decrease iminishina Miimplies as more and more standard units of a commodity (like a cup of tea, hiya the diminshing not a spoon of tea; a glass of milk, not a drop of milk) are consumed te. at a point of time (implying that the consumption of standard units ‘of the commodity is continuous). This law is called law narginal utility , Itis in accordance with this law that MU is shown as diminishing in Table 1 and Fig. 1. It is important to note that when MU diminishes (as from 100 to 90, 80, 70, 60 respectively with every additional unit of the commodity consumed), TU tends to increase but only ata diminishing rate. Because, MU implies addition to TU; if MU declines, addition to TU also declines; accordingly, diminishing MU implies that TU increases only at a diminishing rate. Referring to Table 1, you will find that initially 100 utils are added to TU, then 90, 80, 70, and finally 60. Implying that TU increases but only at a diminishing rate. \CLow of diminishing marginal utiliy states that as more and more standard units ofa ‘commodity are continuously consumed, marginal utiity derived fiom every additional unit must decline. Indeed, it is very natural to happen in respect of all goods and services. oe {tis therefore, called Fundamental Law of Satisfaction’ or Fundamental Psychological Law’. er . Law of Diminishing Marginal Utility is a Fundamental Law Fe CUS \ ‘Two Basic Assumptions Basic assumptions of the law are as under: (i) Only standard units of the commodity are consumed. Like, a cup 2 of tea (not a spoon of tea). (ii) Consumption ie ‘commodity is continuous. Not that one unit of the commodity is consumed now, and the other tomorrow. ite fi Cant. 6. CONCEPT OF CONSUMER'S EQUILIBRIUM Consumer's equilibrium refers to a situation wherein a consumer, maximum satisfaction out of his given income and he has no to make any change in his existing expenditure. In other words, consumer is in equilibrium when he regards his actual behaviour a the best possible under the circumstances and feels no necessity to change his behaviour as long as circumstances remain unchanged, [=e ee? Assumptions Relating to Consumer's Equilibrium (1) Rational Consumer: Consumer is assumed to be rational, 4 rational consumer is one who wants to get maximum satisfaction out of his given income. (2) Cardinal Utility: Utility of every commodity can be measured in terms of cardinal numbers, such as, 1, 2, 3, 4, etc. (3) Independent Utility: It is assumed that the utility that a consumer ’ gets from a commodity depends upon the quantity of that very commodity alone. It is not affected by the consumption of other goods. (4) Marginal Utility of Money is Constant: It is assumed that money measures the marginal utility of a commodity; as such, its own marginal utility should remain constant so as to serve as an ideal measure. 7. MARGINAL UTILITY ANALYSIS AND CONSUMER'S EQUILIBRIUM Now, we address the basic question of this chapter: How much of a commodity a consumer buys so that he maximises 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 or more commodities are consumed. Following is brief description of both the situations, » Consumer’s Equilibrium: One Commodity Case Purchase of a commodity by a consumer depends on three factors (i) Price of the commodity. (ii) Marginal (and total) utility of the commodity. (iii) Marginal utility of money. *« eSWhat is Marginal Utility of Money? Marginal utility of money refers to ‘worth of a rupee’ to o consumer. What is worth of a rupee? A consumer defines it in terms of utility that he derives from a standard basket of goods that he can buy with a rupee. Example: If a rupee can buy 100 g of sugar, 500 g of rice and 500 g of salt (which represent a standard basket of goods to the consumer), and if total utility from these goods is (soy) 4 utils to the consumer, then 4 is to be taken as marginal utility of money. This becomes his ‘standard reference’ whenever he is buying any commodity. Buying a unit of commodity-X for a rupee would mean the consumer expects 4 units of utility from the consumption of commodity-X. Thus, MU, (marginal utility of money) becomes a measuring rod for a rupee worth of satisfaction. Important: It is assumed that MU, is constant. Simply because, itis a measuring rod for « rupee worth of satisfaction Let marginal utility of money for the consumer = 2 utils (referring to the utility he expects to receive when he spends & 1). Let X be the commodity he intends to buy, Let P, (Price of X) = & 4 per unit. Marginal Utility Schedule of x is taken to be as follows: Table 3. Marginal Utility Schedule of Commodity-X Units of, Muy ] Commodity-X (utils) 1 i 20 | 2 | 18 3 16 4 | 5 o 6 5 Using the scale that 2 utils = € 1, he can express MU, in terms of rupees, as in Table 4. Table 4. Conversion of MU, into Rupees or Money Worth of MU F MU, MU in terms of Rupees (money worth of MU) when 2 utils = & 1 Consumers Equilibrium— Utility Analysis 55Now comes the basic question: How many units of X the con: will purchase to be in a state of equilibrium? To answer this Westion, let us proceed step by step: = Will he buy 1st unit of x? Yes. Because: MUy= 20 utils 2 a = ee | =Worth €10, [20 utils =<" = 8 | while Py = 4 What he pays (& 4) is less than what he gets (worth & 49) ) Hence, he must buy the 1st unit of X. = Will he buy 2nd unit of X? Yes. Again, because: MU,= 18 utils = Worth & 9, while P, == 4 What he pays (& 4) is less than what he gets (worth Z 9). Hence, he must buy the 2nd unit of x. Continuing like this, he will stop buying X, only when: 5 MUs (in terms of rupees) = Py 't occurs when the consumer buys 4 units of commodity-x. Here, MUs (in terms of rupees) = P, = % 4 Diagrammatic Illustration Fig. 4 shows consumer equilibrium when only one commodity is purchased y Consumer Equilibri im: One Commodity Case ain 2% \ 28 ; : =e [Point of equilibrium: 3& ve P= MUs (in terms of rupees) Bg Py Be ze ‘MU, (in terms of rupees) x 4 Consumption of Commodity-x (units) (Note: Fig. 4 is NOT based on th, e data in Ta smoothed MUx curve to key ble 4. We have drawn 4 P the diagra m simple] y Microeconomics EE ~n AU Pee coerce It tes the price that the consumer is willing to pay for each ye unit of the commodity. is struck at point C when the price he is willing to is exactly equal to the price he actually pays. In a state of ‘equilibrium, the consumer buys 4 units of commodity-x. Alternative Presentation of Consumer Equilibrium: One Commodity Case \ Let X be the commodity that the consumer buys MU, (rupee worth of satisfaction) = 2 utils P,, (price of commodity-X) = 4 Marginal Utlity Schedule be as under: Units of Commodity-X MU,, (Utils) 1 2 3 4 The equilibrium is struck when rupee worth of sumer expects MU,\ 10 get (MU) i equl to rupee worth of satisfaction that he actualy et ( Thus, equilibrium is struck when: . MU, ra Py a T Rupee worth of satisfaction that Rupee worth of satsfoction thot the consumer actually gets the consumer expects to get With reference to the above schedule, the consumer strikes his equilibrium when:fon of X increases, MU, jutiity). I shall stop at 2 point when: commodity-x, a consumeron Good. Thus: if MU, = 100 and Py =% 20, then 2 would ‘mean that marginal utility per Tupee spent on Good-\ 1U, = 20, Py = 4, MU, = 25 and Py = 5. Is the consumer in a state of equilibrium, if MUy = 5? Solution: The equilibrium is struck when MU, MU. Fan. Fy Substituting the values, we find 2025. 4 5 implying that the consumer is in a state of equilibrium. Example 2. Let MU, = 25, P, = 5, MU, = 30 and Py = 5. Is the consumer in a state of equilibrium? Y = MU 5Mlustration Now present a simplified tabular illustration ‘equilibrium, considering Good-x and Good-y. m@ssumption that P, = P, = % 1. With this assum MUx = MU, \ x eae MUy} changes as under Of con is based ption, eq equation { MU, = MU, = MU,, Note that MU, now shows margin another unit of X is purchased or w! Likewise, MU, al utility of commodity hen another rupee is spentd shows marginal utility of commodity-Y when unit of Y is purchased or when another rupee is spent on Y. NOW to Table 5 showing MU, and MU, when successive units of X are purchased Schedule showing MU,, MU, and Consumer's Equll ®, the condition becomes,combination of X and ¥, that the consumer on, and he strikes his equilibrium. ¢ Illustration 's equilibrium (two commodities) is illustrated through Fig. 5 ve clara is based on the data-set of Table 5 Consumer's Equilibrium:Two Commodities Case Point of Equilibrium . MU, = MUy alts.) and Y Consumption of Commodity-X - » 10 5 4 Sah een ay —— Consumption of CommodityY | ‘Assumption: P= Py, The figure shows that the equilibrium is struck at point Q where N MU, = MUy, The consumer consumes 4 units of commodity-X and 6 units of commodity-y. Summing up the two commodities case, we can state that the consumer strikes his equilibrium when he is in a state of ‘equi-marginal utility’. This occurs when the last rupee spent by him yields equal marginal whether he spends it on Good-X or Good. This is known as nal utility states that the consumer strikes his equilibrium when it by him) gives him equal marginal utility whether he spends it onConditions of Consumer's Equilibrium using Marginal Utility Analysis Conditions of consumer's equilibrium are spe cified separately for one commodity case and two commodity case, as under: ‘One Commodity Case 1. Rupee worth of marginal utility actually received by the consumer is equal to ‘marginal utility of money as specified by the consumer himself i Fist It simply means that the rupee worth ‘of MU actually received Is exactly equal to the rupee worth of satisfaction as desired by the consumer 2. Marginal utility of money (MU,,) remains constant. As, it is 2 measuring rod of rupee worth of satisfaction, 3. Law of diminishing marginal utility holds good. In case MU tends to rise, ‘consumption of a commodity will never reach an end. Equilibrium will never be struck ‘Two Commodity Case 1. Rupee worth of marginal utility should be the same across Good-X and Good-Y, and equal to marginal utility of money. Mus Pe This simply means that the rupee worth of MU derived from either commodity is exactly equal to the rupee worth of saristaction as desired by the consumer. MUy _ Ree 2. Marginal utlity of money remains constant. 3. Law of diminishing marginal utility holds good, [Note: Conditions 2 and 3 are the same in both the cases. Only condition 1 is different.‘Xin relation to ¥ will induce the buyer to buy less of X and “ d d, MU, will rise. When more of Y is purchased, MU, will fall. Briefly, when P, rises, less of X and more of Y will be purchased 8. THE BASIC LIMITATION OF UTILITY ANALYSIS «7 The basic limitation of utility analysis relates to the basic assumption of this analysis: that utility can be expressed in cardinal numbers. | implying that utility can be measured in units like 1, 2 and 3. |s it really possible? Do you, as a consumer, ever express your satisfaction in terms of units like 1, 2 and 3? Perhaps never. Satisfaction at best can be ranked as high or low. Or, it can be compared when two goods are simultaneously consumed. It is hard to measure it in figures. It is owing to this limitation of utility analysis, that Hicks challenged y the relevance of this technique in explaining consumer's equilibrium Instead he offered the technique of Indifference Curves Analysis, the subject matter of the next chapter.; CONSUMER'S EQUILIBRIUM— _ INDIFFERENCE CURVE ANALYSIS Vv 1. IC ANALYSIS A UTILITY ANALYS According to this or less). It is never expressed in term 2. ASSUMPTIONS OF IC ANALYSIS OF CONSUMER'S EQUILIBRIUM IC analysis of consumer's equilibrium is based on the following assumptions: {()) Money income of the consumer is given and does not change (W) The consumer spends his income on such goods which can be substituted for each other, like apples and orangesar's preference (or scale of Preference) for is well defined. Generally speaking, his intensity, or a good would increase when he has less of it i intensity of desire for a good would decrease when h, of it, } E ¢ {iv) More of a good always gives more satisfaction to the cor — ® Thisis called ‘monotonic preference’ for a good. (The as ke 'e has Sump is made to simplify the description of IC analysis.) {y) The consumer is rational. He always maximises his Satistactig 3. INDIFFERENCE SET AND INDIFFERENCE CUR, Consider a situation when a consumer is spending his given j across goods A and B, Let Good-A be apples, and Good, Consider these goods as substitutes of each other Consider Table 1, showing different combinatio oranges. NCony 8 be orang 5 of apples ai Table 1. Different Combinations of Apples and Oranges oe ee eee 7 aes 10 B | 2 7 ¢ | 3 5 | > | 4 Note the following observations relating to T: (i) Combinations A, B, C and D are specified by the consume according to his scale of preferences for the two goods, (ii) Each combination offers the same level of satisfaction to tit , Consumer. So that (in terms of the level of satisfaction), Combinali 4 A= Combination B = Combination C = Combination D Iii) AS there is no difference among comiffnations A, By D, we may say that the consumer is indifferent Combinations, Together, these combinations formal Set’ of the consumer, Indifference sets 0 set of those combinations off the same level of satisfaction. So thot the en in his indifference set ieEach point on the curve (like A, B, C, ..) shows one combination of two goods (apples and oranges). Since each combination offers the same Jevel of satisfaction to a consumer, this curve is called indifference curve. curve is a diagrammatic presentation of an indifference set of a consumer It shows different combinations of two commodities (like apples and oranges) | offering the same level of satisfoction to the consumer. 4. FEATURES/PROPERTIES OF INDIFFERENCE CURVES tures/properties of indifference curves. Following are the principal f (i) IC Slopes Downward IC slopes downward from left to right. It means that IC has a negative slope. It implies that if the consumer decides to have more of one good, he must have less of the other. It is only then that the remain constant at different points of the IC. Let Satisfaction level would r consumer has 5 oranges Us refer to Fig. 2. At point A on the IC, the and 2 apples. Moving from A to B, he has 3 apples (one more than before) and 3 oranges (2 less than before). When the consumer meves from point A to B, and he has 3 apples instead of 2, his satisfaction level from apples must rise. Since A= B (in terms of satisfaction ‘Must k that the rise in satisfaction Ee Became: less of oranges, 1° ty the fallone @dditional unit of Good. involves a sacrifice of 2 units ‘of Good-y) Since: slope, oF i I’ must slope downward,I Pe ices ae how ae The slope of IC is called marginal rate of lt indicates the rate at which the consumer is willing to ‘one good for the other. ore F “Or MRS refers to the rate at which the consumer is willing to sacrifice GoodY (on (on X-axis) Why should MRS decline? As more and more units of Good-X are consumed by the consumer, his intensity of desire for Good-X tends to decline. Implying that ER Targinal utility of Good tends to all (in accordance with thelawot diminishing marginal utility). On the other hand, as more and more Low ok units of Good-Y are given up, his intensity of desire for Good-Y tends to rise.)implying that marginal utility of Good tends to rise with > Way A yyy every additional unit of it being sacrificed. It is because of this, for . 4 every successive ve unit of Good-X, the consumer is willing to give up WY = AY less and less amount of Good-Y. Accordingly, x (sacrificing Y per unit of additional X) tends to fall as we move down the 16. Thus, ay See is convex fo the origin because MRS tends to decline. (ex tps Awe Fig, 4 illustrates this point. Between points A and B, the consumer is willing to give up 1.5 units of Good-Y for 1 more unit of Good-X. So that, MRS = - x =- 13 = ~1.5. But, as we move down the curve, we find that between points B and C, the consumer is willing to give up 1.5 units of Good-Y only when. he gets 2 units of Good-X in return (or 0.75 units of Good-Y are see oF 1 more unt of Good), So that, MRS~- AY --15. 0 75, D, AY= osm ax-2 sasha hl‘2-15 (or MRS =-15) Vamnpeen A tape c= AT = Pee aechnak A -y-ttes-™ | ay . 08 | fo trereon pein 0 sope ttc» AY = SF : sting RS ad 0 coment of a oa IC is Convex to the Origin = -0.25 (oe MRS = -025) Ay Itis because MRS (=<) tends to decline e curve, left t 4 (Note thor =~ i identical wit the slope of IC. So that declining MRS means | slope of IC tends to decline as we move down this ie ns bis the dectining MRS that m f 1g MRS kes indifference curve as convex to th origin. Higher the MRS, (ili) Higher IC shows Higher Level of ion indifference bove th curves 0 he other. A setPeetettion than IC,, and IC, indicates than IC,| map corresponds to different level of , IC corresponds to higher level of income. EEHOTS a | @ Show that higher IC offers higher level of satisfaction. fans. Refer to Fig, 6. . Consider points R (on the lower IC) and S (on the higher IC). Both at R and S, consumer has OK amount of Good, But at S, the consumer has Ol; > amount of Good-X which is greater than S OL (the amount of Good-x at point R). o Higher IC means higher level of satisfaction | Icy > We know, more of a good means more | . Icy | satisfaction. | Hence, the conclusion that IC, offers g————_1__|___y higher level of satisfaction than IC,. ee | (iv) ICs do not Cross or Intersect Each Other oe if they do? Well, we do not get logical results. Fig. 7 illustrates ow, ‘A= B (being on the same IC,) A=C (being on the same IC,) © B=C.But thisis not logical.= C, we can conclude that B at both B and C, the CONsUMption of Go, OK). But at C, the consumption of Good-x (~ 8 KB). Implying that C must be Offering hip than B (¥) IC does not touch X-axis or Y-axis This is because 1C analysis considers the consu simultaneously. If 1¢ touches Y-axis (as in Fi the consumption of Good is zero. Likewise, if IC touches X-axis (as in consumption of Good-y is zero. Mption of 3 8), it would mes 'g. 9), it would Mean tj Good-x 5. CONSUMER'S BUDGET (BUDGET SET AND BUDGET LINE) Let us assume that a consumer has a budget of € 60 to be spent Good-1 and Good-; 1 2. Also, assume that price of Good-1 is % 2 per and price of Good-2 is & 4 Per unit. Accordingly, we find the follo Budget set of the consumer This set shows Consumption possibi for the consumer, Biven his income and Prices of Good-1 and Goo Table 2. Budget set of eiSor ay the Consumerits of it. Alternatively, a consumer can buy 10 units Good: ding 10 x % 2 = % 20 on it) and 40 units of Good-2 40x81 =% 40 on it). Also, he can buy 20 units of Good-1 ‘spending 20 = % 2 = % 40 on it) and 20 units of Good-2 (spending 0 x % 1 = % 20 on it). Likewise, you can think of various other combinations that a consumer can buy, given his income and prices J} of Good-1 and Good-2. iven prices of udget ads ‘and income of the consumer. The budget set equation (briefly called P|X, +P)X) $Y Here,P, = Price of Good-1;X, = Quantity of Good-;P, = Price of Good-2;X, = Quantity of Good-2;Y = Total expenditure or total budget. Budget Set is also called Budget Constraint as it shows the limit (constraint) up to which the consumer can buy a set of two goods with his given income. Ans. Budget set ine on P, (Price of Good-1), P, (Price of Good-2), and ¥ (Consumer's income). Change in any of these variables will lead to a change | in budget set. Diagrammatic presentation of the data-set of offers a budget line, as in Fig. 10 ieee yer endaw lay This budget line corresponds to the \ cage ae oe 9 following equation, called Budget Line er and eo AQO-4 we Ex PIA enw We PAX) + PX =¥ Y: Total expenditure or total budget. P, : Price of Good:1. X,: Quantity of Good-1 P,: Price of Good-2. + Quantity of Good-2. S\ 0g~a m7alled Budget Line, Why? Line aé (in Fig, 10) Is ¢ mer with his given flecause, a consu f Good-1 or 60 units of Good2, oF ather | { the line ab. Fach point on the line abi 11 and ¢ 1 hich a UTE nt and given the prices of Good-1 and dget line is a line sh iifferent possible combina " ti 1 his budget pu Good Tart ood. ise fin t 14 1 1 iT 1 1 Price of 1 unit of { eat ' ' « Thu ' ) hus, price line st price rati hows th units of 12 a of Good Budget Line and Attainable & Non-a Budget line is a line that separ eth L called feasible combinations) from Theta: combinations. Ca 4 consumer go b eyond the budge rot, given his budget (ine Thus, any point beyond the budvet 4 ‘sade We tine ab The diagram shows b ws budget line when: consumer Price af Good-1 ~ © 2 per unit Pelee of Gamat” rice Of Good. binations nbinations (ali le (nonfeasiblé) t line? Certainly rd & Goodd 1 norattainabll trates this poll 's budget = © 608 @ 1 oer unt. | |(i) Budget tine is defined in terms of this equation: Pik, + PK = i ‘et includes all combinations of goods (i) Budget ine includes only such combinations of ‘Xand ¥ (elven their prices) on which the actu ‘goods X and ¥ (given their prices] on which the expenditure is equal to or less than the given actual expenditure by the consumer is exactly income of the consumer. equal to his given income. Specifically it does not include such combinations which are attainable but where: consumer's expenditure < consumer's Slope of Bud! Slope of budget line/price line = y as in Fig. 12 Slope of Budget Line/Price Line feasible) Certainly Good: inablmuch of Good-Y is to be sacrificed for @ unit of Good x, ust be noted that the slope of price line is constant, siny Hine is a straight line (we know, a straight line has a slope). Further, price line is Good-X and Good-Y are | drawn as a straight line, hecary 96 aken as given in the market Budget Line Slopes Downward Budget line slopes downward, Because, given consumers’ Prices of goods X and Y, the consumer can buy more of when he buys less of Goody (Refer to | income, Goody, able 2 for details) Changes in Budget Set Changes in budget set are indicated by (i) Shifts in budget line, and (ii) Rotation of budget line Following is a brief description of these change z (i) Shifts in Budget Line Ewvak ag Budget line shifts forward Of the consumer incre “Vda (without changing its aSeS. Prices are assumed as constant, ward (without changing its slope) when ing . Pri slope) when ingConsequent upon increase and decrease in consumers’ income, bis budget line shifts to the right and left as shown in Fy 14. Shift in Budget Line 120 Budget line shifts forward wherr CONsUMers income increases from ae 2 to® 120 (P,P, remaining constant) 3 60 Existing budget line wher consumers income = 8 60, rmenmet 0 Budget line shifts backward wher: consumer's income decreases from | | 260102 30 (P,P; remaining constant) eX a Good-1 ood-X only ¥ {ii) Rotation of Budget Line (a) Budget line rotates to the right when: P, or P, falls, as in and rs > } on F} iS hen income | Fa L 15} hen income © > | 4 a 5 g 3 & 8 3 ‘When P; falls ' ae ab -«aby dca | ae wae by Good. Good-X In Fig. 14, Py falls and budget line rotates to the right starting from the Y-axis. In Fig. 15, Py falls and budget line rotates to the Tight starting from the X-axis. Conran Cae Mt 87 Ree ts aEWhen Py rises ab ab, 6 Good-x In Fig. 16, Py rises and budget line rotates to t from the Y-axis. In Fig. 17, Py rises and budg left starting from the X-axis he left start ine rotates to the 6. OPTIMUM CHOICE OF THE CONSUMER: CONSUMER'S EQUILIBRIUM Consumer’ im refers to optimum choice igre: he imises his satisfaction, In term Curve analysis, the cons 1 consumer. if s of indifferenca umer reaches his optimum choice when two conditions are satisfied: 2 sows i Be *.. a op he () Rs, = e Note: The terms budget line/price line + ene | are used interchangeably. These 4. it I are synonyms of each other t Slope of IC Slope of Price Lin e/Budget Line P So that, in a state of equilibriu: ach other. ™, IC and price line are tangent i is convex to the origin at t Offers diagrammatic illust assumption that Goo iy 1c he point of equilibrium Fig. 18 ration of con th sumer’s equilibrium. € consumer is Spending his gi PGCPLY only. & Pyand Ps artah =2 1). In the diagram, E is the Point of equilibriul litions of quilibrium are Satisfied i the point of equi ibrium. joe consumer is buying 15 units of EE MHINE his satisfaction,d Price Line are tangent to each other t us take an illustration: EMARS xy = 2 : 1, indicating that the consumer is w ne 2 units of Goody for 1 unit of Good-X P Let 5 =2: 4, indicating that the price of Go y of Good-y. Or, that 7 unit of Good-X can b 2 units of Goody. Py Thus, when MRS,, = 2: 1 and ree 1 consumer must be in a state of equilibrium, b. the consumer is willing to substitute X for Y is at which the market allows X to be substi Condition 2: IC is Convex at th Eq At the point of equilibrium, IC must be Convex to the origin. Ths because, marginal utility derived from every com must deciat as we consume more of it. If this law does not h can never reach a point of stable equilibrium reached when Every additional unit of a com More satisfaction? Certainly not.