CONSUMER’S EQUILIBRIUM

ORDINAL UTILITY APPROACH

The real elaboration of the Indifference Curves was made by J. R. Hicks and R. G. D. Allen.

Modern economists disregarded the concept of 'cardinal measure of utility) They were of the opinion that
utility is a psychological phenomenon and it is next to impossible to measure the utility in absolute terms
According to them, a consumer can rank various combinations of goods and services in order of his
preference.

For example, if a consumer consumes two goods, Apples and Bananas, then he can indicate:

1. Whether he prefers apple over banana; or

2.Whether he prefers banana over apple; or

3.Whether he is indifferent between apples and bananas, i.e. both are equally preferable and both of them
give him same level of satisfaction.

Ordinal utility is the utility expressed in ranks.

Indifference curve

Indifference curve refers to the graphical representation of various alternative combinations

Of bundles of two goods among which overline the consumer is indifferent.

Indifference curve is a locus of points that show such combinations of two commodities which give the
consumer same satisfaction.
As seen in the schedule, consumer is indifferent between five combinations of apple and banana.
Combination 'P' (1A + 12B) gives the same utility as (2A + 8B) (3A + 5B) and so on. When these
combinations are represented graphically and joined together, we get an indifference curve as shown

In the diagram, apples are measured along the X-axis and bananas on the Y-axis. All points (P. QR, S and
T) on the curve show different combinations of apples and bananas. These points are joined with the help
of a smooth curve, known as indifference curve IC1 An indifference curve is the locus of all the points,
representing different combinations, that are equally satisfactory to the consumer.

Every point on IC1 represents an equal amount of satisfaction to the consumer. So, the consumer is said to
be indifferent between the combinations located on Indifference Curve.

Monotonic Preferences

Monotonic preference means that a rational consumer always prefers more of a commodity as it
offers him a higher level of satisfaction.

Example: Consider 2 goods: Apples (A) and Bananas (B)

(a) Suppose two different bundles are: 1ST ; (10A, 10B) ; and 2nd (7A, 7B)

Consumer's preference of 1st bundle as compared to 2ND bundle will be called monotonic preference as 1
bundle contains more of both apples and bananas.

(b) If 2 bundles are: P; (10A, 7B) 2: (9A. 7B). Consumer's preference of 1st bundle as compared to 2nd
bundle will be called monotonic preference as 1" bundle contains more of apples, although bananas are
same.

Indifference Map

Indifference Map refers to the family of indifference curves that represent consumer preferences
over all the bundles of the two goods.

An indifference curve represents all the combinations, which provide same level of satisfaction. However,
every higher or lower level of satisfaction can be shown on different indifference curve.

It must be noted that 'Higher Indifference curves represent higher levels of satisfaction' as higher
indifference curve represents larger bundle of goods, which means more utility because of monotonic
preference.

Marginal Rate of Substitution (MRS)

MRS refers to the rate at which the commodities can be substituted with each other, so that total
satisfaction of the consumer remains the same for example, in the example of apples (A) and bananas
(B), MRS of 'A' for 'B', will be number of units of 'B', that the consumer is willing to sacrifice for an
additional unit of 'A', so as to maintain the same level of satisfaction.
 MRSAB=units of bananas(b) willing to sacrifice/units of apples (a) willing to gain

MRSAB=Delta b/Delta a

MRSAB is the rate at which a consumer is willing to give up Bananas for one more unit of Apple.

It means, MRS measures the slope of indifference curve.

The concept of MRS is explained through Table

combination Apples(A) Banana(b) MRSAB

P 1 15 ---
Q 2 10 5B:1A
R 3 6 4B:1A
S 4 3 3B:1A
T 5 1 2B:1A

As seen in the given schedule and diagram, when consumer moves from P to Q, he sacrifices 5 bananas for
1 apple. Thus, MRSAB comes out to be 5:1. Similarly, from Q to R, MRSA is 4:1. In combination T, the
sacrifice falls to 2 bananas for 1 apple. In other words, the MRS of apples for bananas is diminishing.

Why MRS diminishes?

MRS falls because of the law of diminishing marginal utility. In the given example of apples and bananas,
Combination 'P' has only 1 apple and, therefore, apple is relatively more important than bananas. Due to
this, the consumer is willing to give up more bananas for an additional apple. But as he consumes more and
more of apples, his marginal utility from apples keeps on declining. As a result, he is willing to give up less
and less of bananas for each additional apple
Assumptions of Indifference Curve The various assumptions of indifference curve are:

Two commodities: It is assumed that the consumer has a fixed amount of money, whole of which is to be
spent on the two goods, given constant prices of both the goods.

Non Satiety: It is assumed that the consumer has not reached the point of saturation.

Consumer always prefer more of both commodities, i.e. he always tries to move to a higher indifference
curve to get higher and higher satisfaction.

3. Ordinal Utility: Consumer can rank his preferences on the basis of the satisfaction from each bundle
of goods.

4.Diminishing marginal rate of substitution: Indifference curve analysis assumes diminishing marginal
rate of substitution. Due to this assumption, an indifference curve is convex to the origin.

5. Rational Consumer: The consumer is assumed to behave in a rational manner, i.e. he aims to maximise
his total satisfaction.

Properties of Indifference Curve

1. An indifference curve is convex to the origin because of diminishing MRS. MRS declines continuously
because of the law of diminishing marginal utility.

Therefore, indifference curves are convex to the origin. It must be noted that MRS indicates the slope of
indifference curve.

2. It implies that as a consumer consumes more of one good, he must consume less of the other good. It
happens because if the consumer decides to have more units of one good (say apples), he will have to
reduce the number of units of another good (say bananas), so that total satisfaction remains the same.

3. Higher Indifference curves represent higher levels of satisfaction: Higher indifference curve
represents large bundle of goods, which means more utility because of monotonic preference.

4. As two indifference curves cannot represent the same level of satisfaction, they cannot intersect each
other It means, only one indifference curve will pass through a given point on an indifference map.

In Fig. satisfaction from point A and from B on IC1 will be the same. Similarly, points A and C on IC2 also
give the same level of satisfaction.

However, this is not possible, as B and C lie on two different indifference curves, IC1 and IC2 respectively
and represent different levels of satisfaction. Therefore, two indifference curves cannot intersect each
other.

An Indifference Curve can never touch X-axis or Y-axis

The Indifference Curve analysis assumes consumption of two goods, i.e. two goods are always consumed.

• If indifference curve touches Y-axis, it would mean that consumption of commodity on the X-axis is
zero.
 • . Similarly, if indifference curve touches X-axis, it would mean that consumption of commodity on
the Y-axis is zero.

So, an indifference curve can never touch any of the axes.

BUDGET LINE

Budget line is a graphical representation of all possible combinations of two goods which can

be purchased with given income and prices, such that the cost of each of these combinations is

equal to the money income of the consumer.

Budget Line is locus of different combinations of the two goods which the consumer consumes and which
cost exactly his income.

(Let us understand the concept of Budget line with the help of an example:

Suppose, a consumer has an income of ₹ 20. He wants to spend it on two commodities: X and

Y and both are priced at ₹ 10 each. Now, the consumer has three options to spend his entire

income: (i) Buy 2 units of X; (ii) Buy 2 units of Y; or (iii) Buy 1 unit of X and 1 unit of Y. It means,

possible bundles can be: (2, 0); (0, 2) or (1, 1).]

When all these three bundles are represented graphically, we get a downward sloping straight line, known

às 'Budget Line'. It is also known as price line.

Budget Set

Budget set is the set of all possible combinations of the two goods which a consumer can afford,

given his income and prices in the market.

Budget set includes all the bundles with the

total income of ₹ 20, i.e. possible bundles or Consumer's bundles are: (0, 0); (0, 1); (0, 2); (1, 0);

(2,0); (1,1). Consumer's Bundle is a quantitative combination of two goods which can be purchased by

a consumer from his given income.

Budget Line Vs Budget Set

Budget Set and Budget Line are two distinct concepts.

(1) 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.

Diagrammatic Explanation 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 7 4 each and banana at 2 each, then the consumer can determine the various
combinations (bundles), which form the budget line. The possible options of spending income of 20 are
given in Table

Budget schedule

Combination Cream biscuit Plain biscuit Budget

(@ ₹10 per packet) (@ ₹5 per allocation
packet)

A 0 10 10 × 0 + 5 × 10
= 50

B 1 8 10 × 1 + 5 × 8 =
50

C 2 6 10 × 2 + 5 × 6 =
50

D 3 4 10 × 3 + 5 × 4 =
50

E 4 2 10 × 4 + 5 × 2 =
50

F 5 0 10 × 5 + 5 × 0 =
50
Number of apples are taken on the X-axis and bananas on the Y-axis. At one extreme (Point 'a'), consumer
can buy 10 plain biscuits by spending his entire income of 50 only on plain biscuits. The other extreme
(Point f'), shows that the entire income is spent only on cream biscuits Between a and f, there are other
combinations like e, d, c and b. By joining all these points, we get a straight line AB' known as the Budget
Line or Price line.

Every point on this budget line indicates those bundles of apples and bananas, which the consumer can
purchase by spending his entire income of 20 at the given prices of goods. of goods.

Important Points about Budget line

1. Budget line AB slopes downwards as more of one good can be bought by decreasing some units of the
other good.

2. Bundles which cost exactly equal to consumer's money income (like combinations

a to f) lie on the budget line.

3. Bundles which cost less than consumer's money income (like combination D) shows under spending. They
lie inside the budget line.

4. Bundles which cost more than consumer's money income are not available to the consumer. They lie
outside the budget line

Algebraic Expression of Budget Line

The budget line can be expressed as an equation P1x1 + P2x2 = M'

Where

M =Money income;

Qa = Quantity of apples (A);

Qb =Quantity of bananas (B) :

Pa =Price of each apple; P Price of each banana.

All points on the budget line AB' indicate those bundles, which cost exactly equal to "M'.

Slope of the Budget Line

In the example of apples and bananas, slope of the budget line will be number of units of bananas, that the
consumer is willing to sacrifice for an additional unit of apple.

Slope of Budget Line=units of bananas(b) willing to sacrifice/units of apples(a) willing to gain=delta b/delta
a

The slope of budget line is equal to 'Price Ratio' of two goods

Price Ratio or Market 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

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), then he will have to
give up some amount of good 2 (say, Bananas or B). The number of bananas needed to be given up to gain 1
apple depends on the prices of apples and bananas.

It means, consumer will have to give PA/ PB units of Bananas to gain one apple.

PA/ PB is nothing but the price ratio between Apples and Bananas. So, it is rightly said that Price Ratio
indicates the slope of Budget Line.

Properties of Budget Line

The two main properties of Budget line are:

A. Budget Line is Downward Sloping: Budget line has a negative slope, ie. it slopes downwards as more of
one good can be bought by decreasing some units of the other good.

Budget Line is a straight line: The slope of Budget line is represented by the Price Ratio,

As Price Ratio is constant throughout, the budget line is a straight line.

Budget line is drawn with the assumptions of constant income of consumer and constant prices of the
commodities. A new budget line would have to be drawn if either (a) Income of the consumer changes, or
(b) Price of the commodity changes.

Let us understand this with the example of apples and bananas

If there is any change in the income, assuming no change in prices of apples and bananas, then the budget
line will shift.
RIGHTWARD SHIFT IN THE BUDGET LINE DUE TO INCREASE IN INCOME.

LEFTWARD SHIFT IN THE BUDGET LINE DUE TO DECREASE IN INCOME.

Effect of change in Prices (Apples and Bananas). If there is any change in prices of two commodities,
assuming no change in money income of consumer, then budget line will change

(a) Change in prices of both the commodities: When price of both the goods change, then the budget
line to a1 b1. On the other hand, rise in prices of both the goods will result in leftward shift in budget line
to a2 B2.

(B) Change in the price of commodity on X-axis (Apples): When price of apples falls, then new budget
line is represented by a shift in the budget line (see Fig. 2.10) to the right from AB' to * A_{1} B^ prime .
The new budget line meets the Y-axis at the same point 'B', because the price of bananas has not
changed. But it will touch the X-axis to the right of 'A' at point ‘a1 ‘because the consumer can now
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 ‘A2 B’
(iii) 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 AB1 The new budget line meets the X-axis at 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
'B, because the consumer can now purchase more bananas, with the same income level. Similarly, a rise in
the price of bananas will shift the budget line towards left from 'AB' to AB2.

Budget Line shifts from AB to AB1 due to decrease in price of Bananas

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

CE BY IC CURVE ANALYSIS

• CE is a situation in which consumers derives maximum satisfaction with no intention to change.

• Equilibrium under the IC curve could be attained only by fulfilling the two conditions.
• MRSXY = RATIO of prices or px/py
• MRS continuously falls.

What happens when MRSXY > PX/PY

• It means consumer is willing to sacrifice more units of Y to obtain one unit of X. It induces the
consumer to buy more more of x as a result MRS falls till MRS < px/py.

What happens when MRSXY > PX/PY

• It means to obtain one more unit of X consumer is willing to sacrifice less units of Y. It induces the
consumer to buy less of X and more of Y. As a result MRS rises till it becomes =to the ratio of
prices and the equilibrium is established.
MRS continuously falls

MRS must be diminishing at the point of equilibrium which means i.e must be convex to the origin.

1. In this figure IC,IC2, IC3 are three IC curve and BA is budget line.
2. The highest IC which a consumer can reach is IC2 (with budget line is constraint)
3. The budget line is tangent to IC2 at point E. This is the point of equilibrium where the consumer
purchases OM quantity of commodity X and ON quantity of commodity Y.
4. All other points on the budget line to the left or right of point E i.e. F and G will lie on lower IC i.e
IC1 and indicate a lower level of satisfaction
5. Budget line can be tangent to only 1 IC so consumer gets the maximum satisfaction at point E where
both the conditions are satisfied. That is MRS=PX/PY and MRS continuously falls.

PRACTICALS

Question 1
A person's total utility (TU) schedule is given below. Derive marginal utility (MU)

UNITS 0 1 2 3 4 5

TU 0 10 25 38 48 55

Question 2

A person's MU schedule is given below. Derive TU :

UNITS 1 2 3 4 5 6
CONSUMED
MU 9 6 4 2 0 -2
Question 3
Calculate the missing figures.

UNITS 1 2 3 4 5

TU(IN UTILS) 16 - - - 40

MU(IN UTILS) - 12 8 6 -

Question 4
Suppose the price of a connodity 'x' is given as Rs 8 and the MU (in terms of money) for 4 units is given as :

UNITS 1 2 3 2
MUX 12 10 8 6

Question 5
Given below is the utility schedule of a consumer for commodity X. The price of the commodity is Rs 6 per unit. How many
units should the consumer purchase to maximize his satisfaction? (Assume that utility is expressed in utils and 1
until == Rs 1). Given reason for your answer.

Consumption 1 2 3 4 5 6
units
total 10 18 25 31 34 34
utility(TU)
Marginal 10 8 7 6 3 0
utility (MU)

Question 6
Following is the utility schedule of a person:

units of x 1 2 3 4 5
consumed

MU 50 40 30 20 10

Suppose that the commodity is sold for Rs 4 and MU of one rupee is 5 utils. How many units of the commodity will the
person purchase to maximise his satisfaction ?

Question 7
Suppose that an ice-cream is sold for Rs 30. Laxmi, who loves ice-cream, has already eaten 3. Her marginal utility from
eating the 3rd3rd ice-cream is 90 utils. If MU of Rs 1 is 3 utils, should she eat more ice-creams or should she stop ?
Question 8
The marginal utility schedule for good X and Y are given below. Both the goods are proced at Rs 1 each and income of
Rakesh (an individual) is assumed to be Rs 8. Determine, how many units of both the commodities should be purchased by
Rakesh to maximize his total utility ?

Quantity Marginal utility of X Marginal utility of Y

1 11 19

2 10 17

3 9 15

4 8 13

5 7 12

6 6 10

7 5 8

8 4 6

Question 9

A consumer consumers only two goods X and Y whose prices are Rs 5 and Rs 4 per unit respectively. If MUY=16MUY=16 at
the point of consumer's equilibrium, calculate MUX.

Question 10
A consumer consumes only two goods X and Y. The consumer choose a combination of two good with marginal utility of X
equal to 30 and that of Y equal to 20. If price of good X is Rs 6 per unit, then what will be price of good Y at the point of
consumer's equilibrium ?

Question 11
A consumer consumes only two goods X and Y whose price are Rs 5 and Rs 6 per unit respectively. If the consumer
chooses a combination of the two goods with marginal utility of X equal to 35 and that of Y eqaul to 30, is the consumer in
equilibrium? Given reason. What will a rational consumer do in this situation ? Use utility analysis.

Question 12
A consumer wants to consume two goods. Good A and Good B. Good A is priced at Rs 2 per unit and Good B at Rs 4 per
unit. The income of the consumer is fixed at Rs 20. On the basis of this information, anser the following question:
(i) Write down the bundles that are available to the consumer.
Or
Mention all the bundles which come under the 'Budget Set'
(ii) Find out the bundles which cost exactly Rs 20.
Or
Mention the bundles which can be represented on the 'Budget Line'
(iii) How much units of good A can be purchased if the entire income is spent on the good ?
(iv) Write down the algebraic expression of budget line.
(v) Determine the slope of the buget line ?
Question 13
Suppose a consumer wants to consume two goods which are available in integer units only. If the income of the consumer
is Rs 20 and both the goods are equally priced at Rs 4, write the bundles which cost exactly Rs 20

Question 14
Suppose there are four bundles containing goods x and goods y, bundle (5,5), Bundle (4,4), Bundle (5,4), Bundle (4,5). If a
consumer's perferences are monotonic, then which bundle will be preferred by the consumer ? Give reason for your
answer.

Question 15
A consumer consumes only two goods X and Y whose prices are Rs 6 and Rs 3 per unit respectively. What will be
the MRSXYMRSXY, when the conumer is in equilibrium ?

How many ice -cream will a consumer have, it ice-cream is available free of cost'' ?
In case of free ice-cream, consumer will carry on the consumption till his total utility is maximum. It means, till an additional ice-cream
yields positive satisfaction, consumer will keep on having ice-creams.

As seen in the given diagram, consumer will stop the consumption at the point of satiety (Point 'K'), i.e., where marginal utility is equal to
zero. In the given diagram, this happens at the 5th5th ice-cream.

'Law of diminishing marginal utility will operate even if consumption takes place in intervals''. Defend or refute.
The given statement is refuted. Law of diminishing marginal utility will operate only when consumption is a continuous process. For
example, if one burger is consumed in the morning and another in the afternoon, then the second burger may provide equal or higher
satisfaction as compared to the first one.

'TU remains the same, whether MU is positive or negative''. Defend or refute.

The given statement is refuted. TU increase, when MU is positive, whereas, TU decrease, when MU is negative.

What changes will take place in TU, when (i) MU curve remains above the X-axis, (ii) MU curve touches the X-
axis, (iii) MU curve lies below the X-axis.
(i) TU will increase, but a diminishing rate, (ii) TU will be maximum, (iii) TU starts to fall.
Explain the concept of Marginal Rate of Substitution (MRS) by giving an example. Explain its behaving along
an indifference curve.
MRS refers to the rate at which the commodities can be substituted with each other, so that total satisfaction of the consumer remains
the same.
Example. Let the two goods be X and Y. Given a certain consumption of X and Y, suppose consumer wants one more unit of X. With
increase in one more unit of X, marginal utility of X will reduce. As a result, consumer will be willing to sacrifice less units of Y. As he
goes on obtaining more and more of X, marginal utility of X goes on falling and thus, consumer is willing to sacrifice less and less of Y.
Marginal Rate of Substitution diminishes as the consumer moves downward along the same indifference curve. it shows that consumer
is willing to sacrifice lesser units of a Good Y, in order to gain one additional unit of Good X. This happens due to the operation of law of
diminishing marginal utility.

A consumer consumes only two goods X and Y. At a consumption level of these two goods, he finds that the
ratio of marginal utility of price in case of X is higher than in case of Y. Explain the reaction of the consumer.
It means that at some consumption level, MUX/PX>MUY/Py . In this case, the consumer is getting more marginal utility per rupee in case
of good X as compared to Y. Therefore, he will buy more of X and less of Y. this will lead of fall in MUX and rise in MUY. The consumer
will continue to buy more of X till MUX/PX=MUY/PY

A consumer consumes only two goods X and Y and is in equilibrium. Price of X falls. Explain the reaction of
consumer through the Utility Analysis,
OR
Suppose a consumer spends his entire income on two goods. X and Y. If he has attained the point of
equilibrium through utility analysis, then he will not change his allocation of expenditure on the two goods X
and Y, even if price of good X falls. Defend or Refute.
In case of two goods X and Y, a consumer will be at equilibrium when MUX/PX=MUY/PY. When price of X falls, then rupee worth of
satisfaction from X will be more than Y, i.e, MUX/PX>MUY/PY. Therefore, he will buy more of X and less of Y. this will lead to fall
in MUX and rise in MUY. The consumer will continue to buy more of X till MUX/PX=MUY/PY

What is budget set ? Explain what can lead to change in budget set.
Budget set is the set of all possible combinations of the two goods which a consumer can afford, given his income and prices in the
market.
Budget set is based on the assumptions of constant income of consumer and constant price of the commodities. Any change in the
income of the consumer or/and price of the commodity, will lead to change in the budget set.

Define a budget line. When can it shift to the right ?

Budget line is a graphical representation of all possible combinations of two goods which can be purchased with given income and price,
such that the cost of each of these combinations of two goods which can be purchased with given income and price, such that the cost
of each of these combinations is equal to the money income of the consumer.
Budget Line shits to the right when.
(i) When there is an increase in income, assuming no change in prices of the two goods,
(ii) When there is decrease in prices of both the gods, assuming no change in income of the consumer

State the conditions of consumer's equilibrium in the Indifference Curve Analysis and explain the rationale
behind these conditions
Let the only two goods the consumes are X and Y. The two conditions of equilibrium are:
(1) MRSXY=PX/PY
(2) MRS falls as more of X is consumed in place of Y.
Rationale behind these conditions:
(1) Suppose MRSXY>PX/PY it means that to obtain one more unit of X, the consumer is willing to sacrifice more units of Y as compared
to what is required in the market. It induces the consumer to buy more of X. As a result, MRS falls and continue to fall till it become
equal to the ratio of prices and the equilibrium is established.
(Explanation based on MRS<PX/PY is also correct)
(2) Unless MRS falls as consumer consumes more of X, the consumer will not reach equilibrium again.

Explain the distinction between the equations of buget line and budget constraint.
Let the two goods consumed by the consumer be X and Y. Let m be income.
The equation of budget line is: PXX+PYY=mPXX+PYY=m.
It shows that the whole collection of the combinations of the two goods on the budget line costs the consumer exactly his income.
The equation of budget constraint (or budget set) is: PXX+PYY≤m
It shows that the money spent on the two goods must be equal to or less than the income.

A consumer consumers only two goods X and Y both priced at Rs 3 per unit. If the consumer choose a
combination of these two goods with Marginal Rate of Substitution equal to 3, is the consumer in equilibrium
? Give reasons. What will a reational consumer do in this situation? Explain.
Given Px=3,Py=3 and MRS=3Px=3,Py=3 and MRS=3. A consumer is said to be in equilibrium when MRS=Px/Py Substituting values we
find that:
3>3/3
i.e., MRS>Px/Py
Therefore, consumer is not in equilibrium.
MRS>Px/Py means that consumer is willing to pay more for one more unit of x as compared to what market demands.
−- The consumer will buy more units of xx.
−- As a result, MRS will fall due to the Law of Diminishing Marginal Utility.
−- This will continue till MRS=Px/Py and consumer is in equilibrium.

A consumer consumes only two goods X and Y whose price are Rs 4 and Rs 5 per unit respectively. If the
consumer choose a combination of the two goods with marginal utility of X equal to 5 and that of Y equal to
4, is the consumer in equilibrium ? Give reasons. what will a rational consumer do in this situation ? Use
utility analysis.
Given Px=4,Py=5 and MUx=5,MUy=4Px=4,Py=5 and MUx=5,MUy=4. A consumer will be in equilibrium when MUxPx=MUy/Py
Substituting values, we find that:
54>45 or Mux/Px>MUy/Py
Since per rupee MUx is higher than per rupee MUy, consumer is not in equilibrium.
The consumer will buy more of xx and less of y. As a result MUx will fall and MUy will rise. The reaction will continue
till Mux/Px and MUy/Py are equal and consumer is in equilibrium.

A consumer consumes only two goods. For the consumer to be in equilibrium, why must Marginal Rate of
Substitution between the two goods must be equal to the ratio of prices of these two goods ? Is it enough to
ensure equilibrium ?
Let the two goods be X and Y. MRSXY is the number of units of Y the consumer is willing to sacrifice to obtain one extra unit of X. The
ration of prices is PX/PY which also equals the ratio of the number of units of Y required to be sacrificed to obtain one extra unit of X in
the market.
Initially, when the consumer starts purchases, MRSXYis greater than PX/PY. It means that to obtain one extra unit of X, the consumer is
willing to sacrifice more than he has to sacrifice actually. The consumer gains. As he goes on obtaining more and more units of X,
marginal utility of X goes on declining. Therefore, the consumer is willing to sacrifices less and less of Y each time he obtains one extra
unit of X. As a result, MRSXY falls and ultimately become equal to PX/PYat some combination of X and Y. At this combination, the
consumer is in equilibrium.
If the consumer attempts to obtain more units of X beyond the equilibrium level, MRSXY will become less than PX/PY and his total utility
will start falling. So, he will not try to obtain more of X.
A consumer consumes only two goods. Why is the consumer said to be in equilibrium when he buy only that
combination of the two goods Which lies at that point on the Indifference curve where the budget line is
tangent to the indifference curve? Explain. Use diagram.
Let the two goods be X and Y as shown in the diagram. The tangent is at point E where: slope of indifference curve = Slope of budget
line Or MRSxy=Px/Py
The equilibrium purchase is OxOx of X and OyOy of Y on the indifference curve l2l2

The consumer cannot get satisfaction level higher than l2l2 because his income not permit him to move above the budget line AB. The
consumer will not like to purchase any other bundle on the budget line AB, for example the bundle at C and D, because they all lie on
the lower indifference curve, and give him lower satisfaction. Therefore, the equilibrium choice is only at the tangent point E.

A consumer's income is Rs 200. He spends it on purchase of goods X and Y. Prices of X and Y are Rs 40 and
Rs 20 per unit respectively.
Answer the following question.
(a) Write the equation of his budget line.
(b) Write two such combinations of X and Y which lie on the budget line.
(c) Write two such combination of X and Y which are a part of his budget set but do not lie on his budget line
(a) Given : Price of x(Px)=Rs40x(Px)=Rs40 Price of y(Py)=Rs20y(Py)=Rs20, Income of the consumer = Rs 200. Now, the equation of
budget line will be, 40+20y=20040+20y=200
(b) (i) 1x+8y1x+8y, (ii) 2x+6y2x+6y
(c) (i) 1x+2y1x+2y, (ii) 2x+2y

After reaching the point of equilibrium, consumer would not like to change his allocation of expenditure on
Goods X and Y ever if price of Good X changes. Do you agree ? Comment
No, I do not agree with the given statement. A consumer achieves equilibrium when MUX/PX=MUY/PY
Now, if price of Good X(Px)X(Px) charges, then the equilibrium condition will be disturbed.
In case PxPx increase, MUX/PX<MUY/PY. This would induce the consumer to buy more of Y in place of X.
In case PxPx decrease, MUX/PX>MUY/PY. This would induce the consumer to buy more of X in place of Y.
What does a point on the Budget Line indicate in terms of prices ?
In terms of prices, a point on the Budget Line represents the ratio of price of the good shown on the X-axis to the price of the good
shown on the Y-axis.

An indifference curve does not touch either of the axis.' Defend or Refute.
The given statement is defended. It happens because indifference curve analysis assumes consumption of two goods.
∗∗ If indifference curve touches Y-axis, it would mean that consumption of commodity on the X-axis is zero.
∗∗ Similarly, if indifference curve touches X-axis, it would mean that consumption of commodity on the Y-axis is zero.

A consumer consumes only two goods X and Y and prices of Goods X and Y are Rs 4 and Rs 2 respectively.
What will be the MRSXY when consumer is in equilibrium ?

When the consumer is in equilibrium, MRSxy=Px/Py

substituting Px=4 and Py=2,MRSxy=4/2=2

How will a consumer react when he finds that MRSXY<PX/PY

The consumer will start buying more of Y and less of X till MRSxy=PX/PY

A consumer consumes only one good. The marginal utility from the good is 60 utils and its price is Rs 7 per unit. Indicate whether the
consumer is at equilibrium or not if marginal utility of money for the consumer is 6 utils. What should he do to attain equilibrium ?

A consumer in consumption of single commodity is at equilibrium when:

Marginal Utility of Commodity (MUX)/Marginal Utility of Money (MUM)=PRICE OF COMMODITY
Given: MUX=60utils,PX=RS7MUX=60utils

Substituting values, we find that: 60/6>7

Therefore, consumer is not at equilibrium. As marginal utility is greater than the price, consumer should increase the level of
consumption.

Identify which of the following is not true for the Indifference Curves. Give valid reasons for choice of your
answer.
(a) Lower indifference curve represents lower level of satisfaction
(b) Two regular convex to origin indifference curves can intersect each other.
(c) Indifference curve must be convex to origin at the point of tangency with the budget line at the
consumer's equilibrium. ltbr. (d) Indifference curves are drawn under the ordinal approach to consumer
equilibrium
Out of the given options. (b) is incorrect. Indifference Curves have a property that two ICs cannot intersect. Suppose, there are any two
ICs intersecting each other. As per the figure:
A=C(on IC1)
D=E(on IC2)
But if we see the peculiarity of point B (the point of intersection), this would result into absurd situation
of A=C=B & D=C=BA=C=B & D=C=B, which is not possible, as they are violating the basic definition of the indifference curves.

A consumer has total money income of Rs 250 to be spent on two goods X and Y with prices of Rs 25 and Rs
10 per unit respectively. On the basis of the information given, answer the following questions:
(a) Given the equation of the budget line for the consumer.
(b) What is the value of slope of the budget line?
(c) How many units can be consumer buy if he is to spend all his money income on good X?
(d) How does the budget line change if there is a fall in price of good Y ?
(a) PxQx+PyQy=M
25Qx+10Qy=250
(b) Slope of Budget Line =(−)Px/Py=(−)25/10=(−)=2.5
(c) If Qy is to be Zero
25Qx+10Qy=250
25Qx+10(0)=250
Qx=250/25=10 units
If Py falls, the consumer will be able to buy more of good Y in the same money income pushing the Y-intercept of the Budget Line away
from original, Keeping the X-intercept constant.