Consumer's Equilibrium

A consumer is one who buys goods and services for satisfaction of wants. When a
consumer intends to purchase a product, there are two methods to determine the optimal
quantity:
(i) the utility approach
(ii) the indifference curve approach.
The aim is to obtain the highest satisfaction possible from the money spent on goods and
services.

Utility Approach
Utility
It means realised satisfaction to a consumer when he is willing to spend money on a stock
of commodity which has the capacity to satisfy his want. Realized satisfaction occurs
after consumption, while expected satisfaction occurs before purchase. Utility varies
between individuals, locations, and time periods, and is subjectively determined by the
consumer's desire. Utility can be measured and differs among people, places, and times.
For e.g. Consumption of 2 units of X gives 10 utils.

Assumptions of utility approach

Utility is measurable in monetary terms.
Consumer’s income is given.
Prices of commodities are given and remain constant.

Total Utility
It is the sum of all the utilities that a consumer derives from the consumption of a
certain amount of a commodity. Mathematically, it is calculated as:
TUn = MU1 + MU2 + .....+ MUn

Marginal Utility
It is addition made to the total utility as consumption is increased by one more unit of
the commodity. Mathematically, it is calculated as:
MUn = TUn – TUn – 1 or MUn = ΔTU = Change in marginal utility
ΔX Change in quantity of X

Relationship between TU and MU

Quantity of X TU(X) (Utils) MU(X) (Utils)

0 0 —
1 8 8 = (8 – 0)
2 14 6 = (14 – 8)
 Quantity of X TU(X) (Utils) MU(X) (Utils)
3 19 5 = (19 – 14)
4 23 4 = (23 – 19)
5 26 3 = (26 – 23)
6 28 2 = (28 – 26)
7 29 1 = (29 – 28)
8 29 0 = (29 – 29)
9 27 –2 = (27 – 29)

As the consumer has more of the good, the TU increases

less than in proportion and the MU gradually declines
but is positive.
If consumer is rational, he will stop at 8 units. This is
(X is burger here)
because if he consumes more than 8 units, then TU will
decline and MU will become negative.
TU curve starts from the origin, increase at a decreasing
rate, reaches a maximum and then starts falling.
MU curve is the slope of the TU curve.
When TU is maximum, MU is zero, it is called saturation
point. Units of the good are consumed till the saturation point.
As long as TU curve is concave, MU curve is downward sloping and remains above the
x-axis. When TU curve is falling, MU curve becomes negative.

Law of diminishing marginal utility

According to the law of diminishing marginal utility, as a consumer consumes more of a

commodity, the satisfaction gained from each additional unit decreases until it reaches
zero. After this point, consuming more leads to dissatisfaction. Rational consumers aim to
maximize their satisfaction and avoid going beyond zero marginal utility.
Like in the above table, after consumption of 1 unit of X, one got 8 utils while after one
more unit of X, utility was 6 and 3rd unit onwards it was only decresing.

Assumptions of the law of DMU

Standard unit of measurement: If the unit of measurement is too big or small, the law
won't work. Examples include measuring rice in grams, water in drops, or diamonds in
kilograms.
Homogeneous commodity: All units of the commodity consumed are homogeneous and
perfect substitutes.
Continuous consumption: consumption of successive units of a commodity is necessary
without a time gap.
Mental and social condition of the consumer must be normal: A mentally stable
consumer with unchanged income, preferences, and rational behavior.
 Consumer's Equilibrium
A consumer is said to be in equilibrium when he maximizes his satisfaction, given income
and prices of the commodities.
In economics, the consumer is responsible for choosing what to purchase to satisfy their
wants. Their decisions are influenced by their preferences, income, and market prices.

Case 1 - one commodity case

If a consumer has a fixed income and only consumes one product, they can either spend
their income on the product or save it. If the marginal utility of the product is higher
than the marginal utility of their income, they can increase their total utility by
spending their income on the product.
Thus, a consumer is in equilibrium when he satisfies the following condition:
i.e., MU of the good = Price of the product

Unit of x MU(X) (Utils) Price

1 8 5
2 6 5
3 5 5
4 4 5
5 3 5

A consumer will not buy more than 3 units of X in the above case. This is because if he
buys 4 units of X then the price he pays (Rs. 5) will be more than the MU of x he derives
which is worth Rs. 4. Hence, in order to maximise utility a consumer will buy that quantity
of the good where the MU of the good is equal to the price that he has to pay. Therefore,
a consumer is in equilibrium when he consumes three units of good X because at three
units of good X, MU of good = Price of the product.

Case 2 - Two Commodities Case

We assume that a consumer consumes only two

commodities X and Y and their prices are PX and PY
respectively. The condition required by a consumer to
maximise his utility for two commodities X and Y will be
MU x = P x -1
MUy = Py -2
Divide equation (1) by (2), we get
MU
____x = MU
____ y
Px Py
This is called the law of equi-marginal utility.
"The law states that a consumer will so
allocate his expenditure so that the utility gained from the last rupee spent on each
commodity is equal".
In simple words, A consumer reaches equilibrium when the marginal utility per unit of
money spent on each commodity is equal, indicating that reallocating a rupee between
goods wouldn't enhance their overall satisfaction.

Indifference Curve

An indifference curve shows different combinations of two goods that yield the same
level of utility or satisfaction to the consumer

Assumptions

Rationality: He seeks to maximize consumption benefits within his budget and prices.
Diminishing Marginal Rate of Substitution: The slope of indifference curve is called
Marginal Rate of Substitution (MRS) of X for Y. MRS is defined as the amount of good
Y the consumer is willing to give up to consume an additional unit of good X, while
leaving total utility unchanged.
Consistency of Choice: If consumer is preferring good X over Y, then his choice will
remain same all the time.
Monotonic Preference: Consumer preferences are monotonic when, for any two bundles,
the consumer prefers the bundle with more of at least one good and no less of the
other good compared to the other bundle such as he will prefer the bundle (2, 3) to
bundles (2, 2), (1, 3) and (1, 2) bundles.

Units of Units of ΔY
_____
Combinations Commodity Y Commodity X MRSXY = ΔX
A 16 1 —
B 11 2 5Y : 1X
C 7 3 4Y : 1X
D 4 4 3Y : 1X
E 2 5 2Y : 1X
F 1 6 1Y : 1X

Features
Downward Sloping to the Right: The downward sloping curve indicates that when one
good's quantity decreases, the quantity of the other good must increase to compensate
the consumer, maintaining an equivalent bundle.
Convex to the Origin: An indifference curve is convex to the origin because of
diminishing marginal rate of substitution i.e. slope is diminishing.
Two Curves do not Intersect each other: Indifference curves cannot intersect because if
they did, it would imply that one point is simultaneously better and worse than
another.
 A higher indifference curve represents a higher level of satisfaction: Higher
indifference curve represents more quantities of one or both goods, a higher
indifference curve shows higher utility level.

Indifference Map
A family of indifference curves is called an
Indifference Map. It gives a complete picture of a
consumer’s scale of preference for two goods. Higher
the indifference curve, more is the level of utility.

Budget Line
A budget line is a line which shows all possible combinations of two goods that a
consumer can buy with his given income and prices of the commodities. The equation of
a budget line is:

Px.X + Py.Y = M

PX = Price of commodity X
X =Quantity of commodity X
PY = Price of commodity Y
Y =Quantity of commodity Y
M = Total income of consume
Budget Set: It is the collection or set of all the possible bundles or combinations of two
goods that the consumer can buy with his income and prevailing prices of the
commodities.
Budget Constraint: The budget constraint shows that a consumer can choose any
bundle as long as it costs less or equal to the income she has, given income and prices of
goods.

Assumptions
Income of consumer is given and remains unchanged.
Prices of the commodities are given and remain unchanged.

Explanation
A

OA = If the consumer spends all his income on Movies,

he can buy 8 movies.
OB = If the consumer spends all his income on good X,
he can buy 4 T-shirts.
AB = All combinations of X and Y that a consumer can
buy, given income and prices. Since, by assumption B
there are no savings.
Shifts in Budget line
1. Change in income:
Suppose income of consumer rises by 50 per cent and
prices of both commodities are constant then
consumer’s capacity to buy goods increases. He will buy
more quantities of both goods. As a result budget line
shifts rightward and when income decreases, it shifts
leftward.
2. Change in price of commodity X
Suppose price of commodity X falls, price of commodity Y
and income of consumer remain constant. As a result,
consumer can buy more quantity of commodity X. The
budget line shifts rightward. When price of X rises, it shifts
leftward.

3. Change in price of commodity Y

Suppose price of commodity Y falls, price of commodity X
and income of consumer remain unchanged. As a result,
consumer can buy more quantity of commodity Y. There will
be rightward shift in budget line. When price of Y rises, it
shifts leftward.

3. Same change in price of both commodities

(a) If P(x) and P(y) fall by equal proportion and in same
direction then budget line shifts rightward, it is because
consumer is able to buy more quantities of both goods with
his given income.
(b) If P(x) and P(y) rise by equal proportion and in same
direction then budget line shifts leftward,

Important questions with answers

Question Define utility?

Answer It means realised satisfaction to a consumer when he is willing to spend money
on a stock of commodity which has the capacity to satisfy his want. Realized
satisfaction occurs after consumption, while expected satisfaction occurs before
purchase.

Question Define Marginal Rate of Substitution?

Answer MRS is defined as the amount of good Y the consumer is willing to give up to
consume an additional unit of good X, while leaving total utility unchanged.
Question Explain the relationship between TU and MU curve?
Answer MU curve is the slope of the TU curve.
As long as TU curve is increasing, MU curve is downward sloping and remains
above the x-axis.
When TU is maximum, MU is zero
n TU curve is falling, MU curve becomes negative

Question Explain law of diminishing marginal utility?

Answer According to the law of diminishing marginal utility, as a consumer consumes
more of a commodity, the satisfaction gained from each additional unit
decreases until it reaches zero. After this point, consuming more leads to
dissatisfaction. Rational consumers aim to maximize their satisfaction and
avoid going beyond zero marginal utility.

Question What is indifference map?

Answer A family of indifference curves is called an Indifference Map. It gives a
complete picture of a consumer’s scale of preference for two goods. Higher the
indifference curve, more is the level of utility.

Question Two indifference curves intersect each other. True/False

Answer False, Indifference curves cannot intersect because if they did, it would imply
that one point is simultaneously better and worse than another.

Question Explain Budget line.

Answer A budget line is a graphical representation that shows the different
combinations of two goods or services that a consumer can afford given their
budget constraint. Any point on the budget line represents a specific
combination of the two goods that can be purchased with the available income.
Points above the budget line are unaffordable given the consumer's income,
while points below the budget line represent choices that do not exhaust the
consumer's income.

*NOTE : Worksheet (Important questions of all typology with

answers) is provided as a seperate PDF on website
padhleakshay.com*