2.

Consumer Equilibrium and Demand

Utility: It is the want-satisfying power of a
commodity. According to Cardinal Approach, utility
can be measured in cardinal numbers, such as 1, 2,
3 and 4.
Total utility: It is the total satisfaction derived
from the consumption of a given units of a good.
Average utility: It is utility per unit of the
good. It is calculated by dividing the total
utility by the number of units consumed.
Marginal utility: It is the addition to the total
utility derived from the consumption of an
additional unit of the good.
Law of Diminishing Marginal Utility: According
to this Law, as more units of a good are consumed
continuously and in standard units, the marginal
utility derived from the consumption of every
additional unit will keep diminishing.

Units consumed Total Utility (in Marginal Utility

utils) (in utils)
1 10 10
2 18 8
3 22 4
4 22 0
5 20 (-) 2

In the above diagram, Marginal Utility falls.

Corresponding to this, Total utility will increase
at diminishing rate.
When Marginal Utility is zero, Total Utility is
maximum.
When Marginal Utility becomes negative, Total
Utility begins to fall.
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 Consumer Equilibrium

Consumer equilibrium is defined as the situation in

which a consumer’s utility is maximized and from
which he has no tendency to move.

In the Cardinal approach to Consumer Equilibrium,

utility can be measured in terms of utils.

Consumer equilibrium can be analysed in terms of a

single commodity and many commodities as well.

In case of a single commodity, a consumer is said

to be in equilibrium when the price of the good is
equal to the marginal utility derived from the good
divided by the marginal utility of a rupee.
The most important assumption of this analysis is
that Marginal utility of a rupee is standard
(constant).
Marginal utility of a rupee: It is defined as the
additional utility that a rupee spent will give to
a consumer. A consumer will always have the idea of
marginal utility of a rupee whenever he spends a
rupee.
For example, if a consumer expects 4 utils by
spending a rupee on any good, then the marginal
utility of a rupee for the consumer is said to be 4
utils. A consumer will always look for at least 4
utils whenever he spends a rupee.
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Let marginal utility of a rupee is 4 utils. The
consumer wants to buy orange and the price of an
orange is Rs. 4.

Marginal utility of the consumer is given below.

Units of orange Total Utility Marginal Utility
purchased (in utils) (in utils)
1 20 20
2 38 18
3 54 16
4 64 10
5 64 0
6 59 (-) 5

Due to the Law of Diminishing Marginal Utility, the

marginal utility will keep falling. However, the
consumer has to decide about how many units of
orange he should purchase so that his total utility
is maximized.
Units of TU MU MUX/PX
orange (in (in (PX= 4 Rs)
purchased utils) utils)
1 20 20 5
2 38 18 4.5
3 54 16 4
4 64 10 2.5
5 64 0 0

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 6 59 (-) 5 - 1.25

MU of a rupee is 4 utils and the price of an orange

is Rs.4. Therefore, the first orange has given the
consumer 5 utils per rupee (MU of 20 utils/Price of
orange). Since he expects 4 utils only from every
rupee he spends and he actually gets 5 utils per
rupee, he will purchase the first orange.
The second orange gives him utility of 4.5 utils
per rupee which is also more than his Marginal
Utility of a rupee. So, he will buy the second
orange also.
The third unit of orange gives him 4 utils per
rupee he has spent and it is equal to his Marginal
Utility of 4 utils. So, he will purchase the third
unit as well.

However, if he goes for the fourth unit, he gets

only 2.5 utils per rupee whereas he expects 4 utils
from every rupee spent. As he pays more than what
he gets in terms of utils, he will not buy the
fourth unit.

Thus, a consumer is in equilibrium where

Marginal Utility of a rupee
= Marginal Utility of X/ Price of X
MUx = MUX/PRe

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 Y

Utility (in utils) E

MUMoney

X
O QX MUX/PX

Units
Units of
of Goods
Good XXconsumed
and Y consumed

Consumer Equilibrium: Two goods (or several goods

case)
Similar to the single good case, a consumer will
reach equilibrium in case of two (or several) goods
in the same way.
Since Px = MUX/MURe for good X and PY = MUY/MURe for
good Y, then the equilibrium conditions can be
stated as follows.
Conditions of Consumer Equilibrium
1. MURe = MUX/PX = MUY/PY
2. His Total utility is maximised. (His budget is
exhausted.)
This can be explained with the help of the
following schedule.

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A consumer has Rs.88 with him. He wants to purchase
good X and good Y with his money. The market price
of X and Y per unit is Rs.8. The marginal utility
schedule of goods X and Y is given below.
Units MUX MUY MUX/PX MUY/PY
of good
1 88 40 11 5
2 72 36 9 4.5
3 64 24 8 3
4 56 20 7 2.5
5 48 16 6 2
6 40 12 5 1.5
7 32 8 4 1
8 24 4 3 .5
9 16 0 2 0
10 8 (-) 5 1 - 0.625

In case of two goods, a consumer strikes

equilibrium when
1. MUX/ PX = MUY/ PY and
2. when the Total Utility is maximised. (The
consumer’s income is exhausted.)

In this case, the consumer will find the first

condition satisfied at several points. However, the
equilibrium occurs only when the consumer buys 8
units of good X and 3 units of good Y because not
only MUX/ PX = MUY/ PY but his total utility will be
Page 6 of 8
 424 utils from good X and 100 utils from good Y,
thus totaling 524 utils, where his income is
exhausted.

If he chooses any other combination of goods X and

Y in order to maximize his total utility, then it
will be either his money is not completely spent or
he cannot afford to buy that combination.
Y

E1 E2
Utility (in utils)
MUMoney

MUX/PX MUY/PY

Units of Goods X and Y consumed

If MUX/PY is greater than MUY/PY, then the consumer

will consume more of good X and less of good Y
until MUX/PY is equal to MUY/PY.
Similarly, if MUX/PY is less than MUY/PY, then the
consumer will consume less of good X and more of
good Y until MUX/PY is equal to MUY/PY.

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