CHAPTER 1 UTILITY (CARDINAL APPROACH)

Consumer’s Equilibrium and Demand

Q.1 What is meant by consumer?
Ans. A consumer is one who buys goods and services for 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 from spending his income on various goods and service.

Q.2 What is meant by consumer equilibrium?

Ans. Consumer’s equilibrium refers to a situation under which he spends his
given income on purchase of a commodity (or combination of two goods) in
such a way that gives him maximum satisfaction and he feels no urge to
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change.
Q.3 Define the meaning of Utility?
Ans. Utility is the power or capacity of a commodity to satisfy a human want.

Q.4 Define the meaning of Total utility?

Ans. Total utility refers to the total satisfaction obtained from the
consumption of all possible units of a commodity. It measures the total
satisfaction obtained from consumption of all the units of that good.

For example, if the 1st ice-cream gives you a satisfaction of 20 utils and 2nd
one gives 16 utils, then TU from 2 ice-creams is 20 + 16 = 36 utils. If the 3rd
ice-cream generates satisfaction of 10 utils, then TU from 3 ice-creams will
be 20 + 16 + 10 = 46 utils.
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TU can be calculated as:
TUn=MU1+ MU2 + MU3 + ............ + Mun
Where:
TUn = Total utility from n units of a given commodity
MU1, MU2, MU3, ........,MUn = Utility from the 1st, 2nd, 3rd ...........nth unit
n = Number of units consumed

Q.5 Define the meaning of Marginal utility?

Ans. Marginal utility is the additional utility derived from the consumption of
one more unit of the given commodity. It is the utility derived from the last unit
of a commodity purchased.
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As per given example, when 3rd ice-cream is consumed, TU increases

from 36 utils to 46 utils. The additional 10 utils from the 3rd ice-cream is the MU.

MU can be calculated as: MUn = TUn - TUn-1

Where: MUn = Marginal utility from nth unit; TUn = Total utility from n units;

TUn-1 = Total utility from n — 1 units; n = Number of units of consumption

MU of 3rd ice-cream will be: MU3 = TU3 - TU2 = 46 - 36 = 10 utils

One More way to Calculate MU

MU is the change in TU when one more unit is consumed. However, when

change in units consumed is more than one, then MU can also be calculated as:
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Change in Total Utility ∆𝑇𝑈
MU =Change in number of Units = ∆𝑄
Q.6 Define the relationship between MU and TU.

Relation between Total Utility and Marginal Utility

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⊳ TU increase so long as MU is +ve.
⊳ TU is maximum when MU = 0.
⊳ TU starts declining when MU is -ve.
⊳ Decreasing MU implies that TU increases at a decreasing rate (MU is the
rate of TU).
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.
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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.

Relation between TU and MU

i. TU = ΣMU.
ii. TU increases so long as MU is positive.
iii. When MU is zero,TU is maximum.
iv. When MU is negative, TU starts diminishing.
v. Decreasing MU implies thatTU is increasing at a decreasing rate. 9
Q.7 Explain the law of diminishing marginal utility.
Ans. The law states ‘as more and more units of a commodity are
consumed, marginal utility (i.e., level) of satisfaction) derived from each
successive unit goes on failing.’ Expressed alternatively, as a person
consumes more (or additional) units of a commodity, the additional utility (i.e.,
marginal utility) derived from each successive unit goes on falling because
desire for that commodity tends to fall.
Suppose a hungry man wants to eat. The first chapatti which he eats will give
him maximum satisfaction (utility), say 100 utils. Second chapatti will also
fetch him utility but not as much as the first one because a part of his hunger
is satisfied by eating the first chapatti. Suppose he gets 80 utils from the
second chapatti. For the same reason let utility from the third chapatti by 50
utils and from fourth be 25 utils. It is just possible he may get zeros utility from
the fifth chapatti (because his stomach is full now) and negative (-) utility from10
the sixth one (if he is attracted/compelled to eat it).
Any rational consumer will not consume additional chapatti when it gives
disutility. In short, as a consumer consumes more and more units of a
commodity (here chapattis), intensity of his want for the commodity goes on
failing and a point is reached when he wants no more units of it. This tendency
is also substantiated by the table in in which utility from each successive
orange goes on diminishing.

Remember, MU curve is identical to demand curve. As MU curve falls with

increase in number of units consumed, likewise demand curve slopes
downwards with fall in price of a commodity.

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Q.8 Explain the Assumptions of Law of Diminishing Marginal Utility.
Ans. The law of DMU operates under certain specific conditions. Economists
call them the ‘assumptions’ of this law. These are as follows:
1. Cardinal measurement of utility: It is assumed that utility can be
measured and a consumer can express his satisfaction in quantitative terms
such as 1, 2, 3, etc.
2. Monetary measurement of utility: It is assumed that utility is measurable
in monetary terms.

3. Consumption of reasonable quantity: It is assumed that a reasonable

quantity of the commodity is consumed. For example. we should compare MU
of glassfuls of water and not of spoonfuls. If a thirsty person is given water in a
spoon, then every additional spoon will yield him more utility. So, to hold the
law true, suitable and proper quantity of the commodity should be consumed.
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4. Continuous consumption: It is assumed that consumption is a
continuous process. For example, if one ice-cream is consumed in the
morning and another in the evening, then the second ice-cream may
provide equal or higher satisfaction as compared to the first one.

5. No change in Quality: Quality of the commodity consumed is assumed to

be uniform. A second cup of ice-cream with nuts and toppings may give
more satisfaction than the first one, if the first ice-cream was without nuts
or toppings.

6. Rational consumer: The consumer is assumed to be rational who

measures, calculates and compares the utilities of different commodities
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and aims at maximizing total satisfaction.
7. Independent utilities: It is assumed that all the commodities consumed by
a consumer are independent. It means, MU of one commodity has no
relation with MU of another commodity. Further, it is also assumed that one
person’s utility is not affected by the utility of any other person.

8. MU of money remains constant: As a consumer spends money on the

commodity, he is left with lesser money to spend on other commodities. In
this process, the remaining money becomes dearer to the consumer and it
increases MU of money for the consumer. But, such an increase in MU of
money is ignored. As MU of a commodity has to be measured in monetary
terms, it is assumed that MU of money remains constant.
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9. Fixed Income and prices: It is assumed that income of the consumer and
prices of the goods which the consumer wishes to purchase remain
constant.

10.Perfect Knowledge: It is assumed that the consumer knows the different

goods on which his income can be spent and the utility that he is likely to
get out of such consumption. It means, that the consumer has perfect
knowledge of the various choices available to him.

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Q9. Explain the consumer’s equilibrium in case of single commodity.
Or
Explain why the price which a consumer is willing to pay for a good
equals the marginal utility of that good, when purchasing a good.
Or
Explain the market price of a good, how does a consumer decide as to
how many units Of that good to buy? Explain

Ans. Consumer Equilibrium: consumer’s equilibrium means a situation under

which he spends his given income on purchase of a commodity in such a way
that gives him maximum utility and he feels no urge to change. It is a position
of rest because he does not want to deviate from it or consume less or more
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of it.
A consumer purchasing a single commodity will be at equilibrium, when he is
buying such a quantity of that commodity, which gives him maximum
satisfaction. The number of units to be consumed of the given commodity by a
consumer depends on two factors:

1. Price of the given commodity.

2. Expected utility (marginal utility) from each sucessive units.
To determine the equilibrium point, consumer compares the price of the given
commodity with its utility. Being a rational consumer, he will be at equilibrium
when marginal utility is equal to price paid for the commodity.

We know, marginal utility is expressed in utils and price is expressed in terms

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of money.
However, marginal utility and price can be effectively compared only when
both and stated in the same units. Therefore, marginal utility is utils is
expressed in terms of money.

MU of one rupee is the extra utility obtained when an additional rupees is

spent on other goods. As utility is a subjective concept and differs from person
to person, it is assumed that a consumer himself defines the MU of one rupee,
in terms of satisfaction from bundle of goods.
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Equilibrium condition

Consumer in consumption of single commodity (say X) will be at equilibrium

when:

• Marginal utility (MUx) is equal to price (Px) paid for the commodity; i.e. MU =
Price

• If mux > px , then consumer is not a equilibrium and he goes on buying

because benefit is greater than cost. As he buys more, MU falls because of
operation of the law of diminishing marginal utility. When MU becomes
equal to price, consumer gets the maximum benefits and is in equilibrium.

• Similarly, when mux < px , then also consumer is not at equilibrium as he will
have to reduce consumption of commodity X to raise his total satisfaction20
till
MU becomes equal to price.
Note: In addition to condition of “MU = Price”, one more condition is needed to
attain consumer’s equilibrium “MU falls as consumption increase”. However,
this second condition is always implied because of operation of law of DMU.
So, a consumer in consumption of single commodity will be at equilibrium
when MU = Price.

Let us 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 Rs. 10 per unit. Further, suppose that
marginal utility derived from each successive unit is determined and is given in
table (for sake of simplicity, it is assumed that 1 utils = Rs 1, i.e. MUm = Rs 1)
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Consumer’s equilibrium in case of single commodity (1 utils = Rs 1)

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In fig, mux curve slopes downward, indicating that the marginal utility falls with
sucessive consumption of commodity X, due to operation of law of DMU.
Price (px) is a horizontal and straight price line as price is fixed at Rs. 10 per
unit. From the given schedule and diagram, it is clear that the consumer will
be at equilibrium at point ‘E’, when he consumes 3 units of commodity X,
because at point E, mux = px.

He will not consume 4 units of X as MU of Rs 4 is less than price paid of RS

10.Similarly, he will not consume 2 units of X as MU of Rs 16 is more than the
price paid.So, it can be concluded that a consumer in consumption of single
commodity (say X) will be at equilibrium when marginal utility from the
commodity (mux) is equal to price (px) paid for the commodity. 24
Q10. Consumer’s equilibrium in case of two commodities.
Or
Explain the condition of equilibrium assuming the consumer consumes
only two goods.
Or
A consumer consumes only two goods. What are the conditions of
consumer’s equilibrium in the utility approach? Explain the changes that
will take place if the consumer is not in equilibrium.
Ans. As law of equi – marginal utility is based on law of DMU, all assumptions
of the latter also applies to the former. Let us now discuss equilibrium of
consumer by taking two goods: X and Y.
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The same analysis can be extended for any number of goods. In case of
consumer equilibrium under single commodity, we assumed that the entire
income was spent on a single commodity. Now, consumer wants to allocate
his money income between the two goods to attain the equilibrium position.

According, to the law of equi – marginal utility, a consumer gets maximum

satisfaction, when ratios of Mu of two commodities and their respective price
are equal and MU falls as consumption increases. In means, “there are two
necessary conditions to attain consumer’s equilibrium in case of two
commodities”.

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1. The ratio of marginal utility to price is same in case of both the goods.
• We know a consumer in consumption of single commodity (say X) is at
equilibrium when:-

• Similarly, consumer consuming another commodity (say Y) will not be at

equilibrium when:

Equating 1 and 2, we get:

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As marginal utility of money (MUm) is assumed to be constant, the above
equilibrium condition can be restarted as:

What happens, when is not equal to

• Suppose, > In the 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 to fall in Mux and rise in Muy. The
consumer will continue to buy more of X till =
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• When the consumer is getting more marginal utility per rupee
in Case of good Y as compared to X. this will lead to fall in Muy and rise in Mux.
The consumer will continue to buy more of Y till

It brings us conclusion that is necessary condition to attain consumer’s

equilibrium.

2. Mu falls as consumption increase:

The second condition needed to attain consumer’s equilibrium is that Mu of a
commodity must fall of it is consumed. If Mu does not fall as consumption
increase, the consumer will end up buying only one good which is unrealistic and
consumer will never reach the equilibrium position. 29
Finally, it can be concluded that a consumer in consumption of two
commodities will be at equilibrium when he spends his limited income in such
a way that the ratios of marginal utilities of two commodities and their
respective prices are equal and Mu falls as consumption increase.

Explanation with the help of an example

Let us now, discuss the law of equi – marginal utility with the help of a
numerical example. Suppose, total money income of the consumer is Rs 5,
which he wishes to spend on two commodities: X and Y. both of these
commodities are priced at Rs 1 per unit. So, consumer can buy maximum 5
units of X or 5 units of Y. in table, we have shown the marginal utility which the
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consumer derives from various units of X and Y.
 Consumer equilibrium in case of two commodities
Units MU of MU of
commodity X commodity Y(in
(in units) units)

1 20 16
2 14 12
3 12 8
4 7 5
5 5 3

From table, it is observe that the consumer will spend the first rupee on
commodity X, which will provide him, utility of 20 utils. The second rupee will
be spent on commodity Y to get utility of 16 utils. The reach the equilibrium, 31
consumer should
• purchase the combination of both the goods, when:It happens when
consumer buys 3 units of X and 2 units of Y because: Mu from last rupee
(i.e. 5th rupee) spent on commodity Y gives the same satisfaction of 12 utils
as given by last rupee (i.e., 4 rupee) spent on commodity X, and

• MU of each commodity falls as consumption increase.The total satisfaction

of 74 utils will be obtained when consumer buys 3 units of X and 2 units of
Y. it reflects the consumer’s equilibrium. If the consumer spends his income
in any other order, total satisfaction will be less than 74 utils.

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Q.11 Ice-cream sells for? 20. Priya who likes ice cream, has already
consumed 4. Her marginal utility of one rupee is 4. Should she consume
more ice cream or stop the consumption?

Ans. A consumer attains equilibrium when:

MUX
= MUM
PX

MUX
Substituting the given values, we get = 4 implying that, in a state of
20

equilibrium, Priya's MUX must be equal to 80 utils. If, having consumed 4 ice
creams, Priya's MUX = 80 utils she must stop consuming more. However, if
MUX > 80 she should consume more ice creams till MUX reduces to 80 and in
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terms of its money worth is equal to Rs. 20.
Q.12 Let MUX = 20, PX = 4, MUY = 25 and PY = 5.
Is the consumer in a state of equilibrium, if ΛΛUM = 5?

Solution:

The equilibrium is struck when:

MUX MUY
= = MUM
PX PY

Substituting the values, we find

20 25
= =5
4 5

that the consumer is in a state of equilibrium.

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Q.13 Let MUX = 25, PX = 5, MUY = 30 and PY = 5.

Is the consumer in a state of equilibrium?

Solution:

MUM is not given. Accordingly, the consumer will be in a state of equilibrium,

when:
MUX MUY
=
PX PY

Substituting the values, we find

25 30
<
5 5

Implying that the consumer is not in a state of equilibrium.

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Equilibrium Equation for 'n' Number of Commodities
The logic that a consumer strikes his equilibrium for a set of two commodities
MUX MUY
X and Y when = can be extended to any number of commodities.
PX PY

The equilibrium equation for 'n' number of commodities would be as under:

MU1 MU2 MU3 MUnth

= = =⋯= = MUM
P1 P2 P3 Pnth

Thus, Lipseyand Chrystal state "Each consumer demands each good up to

the point at which the marginal utility per pound spent on it is the same as the
marginal utility of a pound spent on each other good." 37
 𝐌𝑼𝑿 𝐌𝑼𝒀
Q.14. What happens when: 𝑷𝑿
> 𝑷𝒀
?

Ans. This situation implies that by spending a rupee on Good-X, the consumer
gets greater marginal utility than in case of Good-Y. Accordingly, he will spend
more on X than Y As consumption of X rises, MUX will fall. On the other hand,
as consumption of Y falls, MUY will rise. The consumer will stop buying more
MUX MUY
of X in place of Y only when > .
PX PY

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Q.15. How is equilibrium of the consumer affected when MUM happens to
rise, and PX is constant?

MUX
Ans. Equilibrium is struck when: = MUM.
PX

If MUM rises and PX is constant, the consumer will not be in equilibrium.

MUX
Because PX
would then be less than MUM. The consumer will reach back his

equilibrium only if MUX rises, as PX is given to be constant. This will happen

only when consumption of commodity-X is decreased (in accordance with the
law of diminishing marginal utility).

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