CONSUMER EQUILIBRIUM

By- AM S
CONCEPTS
▪ Consumer is an economic agent who consumes final goods or services
for a consideration.

▪ Consumer behaviour is the study of how individual customers, groups

or organizations select, buy, use, and dispose ideas, goods, and
services to satisfy their needs and wants.

It refers to the actions of the consumers in the marketplace and the

underlying motives for those actions
▪ Cardinal Utility Approach:- Marshall’s Utility Approach OR Marginal Utility Approach

▪ Ordinal Utility Approach:- Indifference Curve Analysis OR Hicksian Analysis

▪ * The concept of Utility is used to attain Consumer Equilibrium

Difference
Between
Cardinal
&
Ordinal Approach
 Cardinal Utility Ordinal Utility
Definition
It explains that the satisfaction level after It explains that the satisfaction level after
consuming any goods or services can be scaled in consuming any goods or services cannot be scaled
terms of countable numbers. in numbers. However, these things can be arranged
in the order of preference.
Example
Pizza gives Sam 60 utils of satisfaction, whereas Sam gets more satisfaction from a pizza as
burger gives him only 40 utils. compared to that of a burger.
Measurement
Utility is measured based on utils. Utility is ranked based on satisfaction.
Realistic
It is less practical. It is more practical and sensible.
Used By
This theory was applied by Prof. Marshall This theory was applied by Prof. J R Hicks
Other Name
Utility Analysis Indifference Curve Analysis
 CARDINAL VS ORDINAL APPROACH
Cardinal Utility Approach Ordinal utility Approach
(Marginal Utility Analysis or (Indifference Curve Analysis or
Marshall Utility Analysis): J.R. Hicks analysis):

▪ It states that the satisfaction the consumer ▪ It states that the satisfaction the consumer
derives by consuming goods and services derives from the consumption of goods and
can be measured with a number. services cannot be measured in numbers.
▪ Cardinal utility is measured in terms of utils ▪ Rather, ordinal utility uses a ranking system in
(the units on a scale of utility or satisfaction). which a rank is provided to the satisfaction
that is derived from consumption.
▪ According to cardinal utility the goods and
services that are able to derive a higher ▪ According to ordinal utility, the goods and
level of satisfaction to a consumer will be services that offer a customer a higher level of
assigned higher utils and goods that result in satisfaction will be assigned higher ranks and
a lower level of satisfaction will be assigned the goods and services that offer a lower level
lower utils. of satisfaction will be assigned lower ranks.
▪ Cardinal utility is a quantitative method that ▪ Ordinal utility is a qualitative method that is
is used to measure consumption satisfaction. used to measure consumption satisfaction.
Utility is want satisfying power of a
commodity. There are two types:-

A.Total Utility

B.Marginal Utility
▪ Total utility is the total satisfaction derived from
consumption of given quantity of a commodity at a given
time.
▪ In other words, It is the sum total of marginal utility.
Marginal Utility
It is the change in total utility resulting from the consumption of an additional unit of
the commodity. In other words, it is the utility derived from each additional unit.
CALCULATION OF TU & MU

𝑻𝑼𝒏 = 𝑼𝟏 + 𝑼𝟐 + 𝑼𝟑 + 𝑼𝟒 … … … … + 𝑼𝒏

𝑻𝑼 = ෍ 𝑴𝑼

𝑪𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒕𝒐𝒕𝒂𝒍 𝑼𝒕𝒊𝒍𝒊𝒕𝒚 𝜟𝑻𝑼

𝑴𝑼 = =
𝑪𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒏𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝑼𝒏𝒊𝒕𝒔 𝜟𝑸
LAW OF DIMINISHING
MARGINAL UTILITY

▪ As consumer consumes
more and more units of
commodity the Marginal
utility derived from each
successive units go on
declining. This is the basis
of law of demand.
▪ It will operate only when
consumption is a
continuous process ,
 ▪ (i) When Mu diminishes
RELATIONSHIP BETWEEN TU AND MU but positive Tu increases
at a diminishing rate.
▪ (ii) When Mu is zero, Tu
is maximum.
▪ (iii) When Mu is
negative, Tu diminishes

Coffee Consumed TU MU
1 12 12
2 22 10
3 30 8
4 36 6
5 40 4
6 40 0
7 39 -1
ASSUMPTIONS OF LAW OF
DIMINISHING MARGINAL UTILITY
Cardinal Monetary Consumption
Continuous
Utility measurement of reasonable
consumption
analysis of utility quantity

MU of money
No change in Rational Independent
remains
quality Consumer utilities
constant

Fixed income Perfect

and price knowledge
 CONSUMER EQUILIBRIUM
▪ Consumer's Equilibrium refers to the situation when a consumer is having maximum satisfaction with
limited income and has no tendency to change his way of existing expenditure.

▪ The consumer has to pay a price for each unit of the commodity. So, he cannot buy or consume
unlimited quantity.

▪ As per the Law of DMU, utility derived from each successive unit goes on decreasing.
▪ At the same time, his income also decreases with purchase of more and more units of a commodity.

▪ So, a rational consumer aims to balance his expenditure in such a manner, so that he gets maximum
satisfaction with minimum expenditure. When he does so, he is said to be in equilibrium, After
reaching the point of equilibrium, there is no further incentive to make any change in the quantity of
the commodity purchased.
CONSUMER'S EQUILIBRIUM IN TWO DIFFERENT SITUATIONS:

▪ Consumer spends his ▪ Consumer spends his entire income

entire income on a on Two Commodities
Single Commodity
Consumer's Equilibrium in case of Single Commodity
The Law of DMU can be used to explain consumer's equilibrium in case of a single commodity.
Therefore, all the assumptions of Law of DMU are taken as assumptions of consumer's equilibrium in case of single
commodity.

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 2 factors:

1. Price of the given commodity;

2. Expected utility (Marginal utility) from each successive unit.

To determine the equilibrium point, consumer compares the price (or cost) of the given commodity with its utility
(satisfaction or benefit).
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 of money.

However, marginal utility and price can be effectively compared only when both are stated in the same units.
Therefore, marginal utility in utils is expressed in terms of money.
Marginal Utility in terms of Money -Marginal Utility in utils Marginal Utility of one rupee (MU)

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

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. Mux = Px

If MUx > Px then consumer is not at 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 satisfaction till MU becomes equal to price.
Unit of X Price of X ( Marginal Marginal Utility in Difference Remarks
(Chocolate) Chocolate) Utility Rs. (MUx) 1 utils = 1 MUx & Px
(Utils) Rs.

1 10 20 20/1 = 20 20-10 = 10 MUx >Px, So

Consumer will
increase the
consumption
2 10 16 16/1 = 16 16-10 = 6

3 10 10 10/1 = 10 10-10 = 0 Consumer’s

Equilibrium (MUx =
Px)
4 10 4 4/1 = 4 4-10 = -6 Mux < Px , so
consumer will
decrease the
consumption
5 10 0 0/1 = 0 0-10 = -10

6 10 -6 -6/1 = -6 -6-10 = -16

Note: In addition to condition of "MU=Price", one more condition is needed to attain consumer’s equilibrium:
"MU falls as consumption increases". If MU does not fall, then consumer will go on consuming the commodity and
hence will never attain the equilibrium position. However, this second condition is always implied because of
operation of Law of DMU.

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 10 per unit. Further suppose that marginal
utility derived from each successive unit (in utils and in ) is determined and is given in Table 2.3 (For sake of
simplicity, it is assumed that 1 util-1, i.e. MUM=1)

MUx curve slopes downwards, indicating that the marginal utility falls with successive 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 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, MU, Px He will not consume 4 units of x as MU of 4 is less than
price paid of rs. 10,Similarly, he will not consume 2 units of x as MU of 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 (MU) is equal to price (P) paid for the commodity.

The equilibrium condition can also be expressed as Mux = Mum

Px
Mux= Px

Suppose Price of X commodity is Rs. 6

So to attain the equilibrium condition Mux = 6
So that Mux= Px
i.e. 6 = 6

Unit Total Utility Marginal Utility of X Price of X

1 12 12 6
2 22 10 6
3 30 8 6
4 36 6 6 Mux= Px
5 40 4 6
6 40 0 6
7 39 -1 6
SINGLE COMMODITY CASE

▪ Consumer in consumption of
single commodity of single
commodity will be at
equilibrium when marginal
utility (MUx) is equal to the
price (Px) paid for the
commodity.
CONSUMER
EQUILIBRIUM ▪ Purchase of a commodity by a consumer
depends upon three factors

IN CASE OF ▪ A. Price of the commodity (Px)

▪ B. Marginal ( & Total utility of the

SINGLE
commodity (MUx)
▪ C. Marginal Utility of Money (Mum)

COMMODITY
LAW OF EQUI-MARGINAL UTILITY IS ALSO KNOWN
AS
(1) LAW OF SUBSTITUTION
(2) LAW OF MAXIMUM SATISFACTION
(3) GOSSEN’S SECOND LAW
The Law of DMU applies in case of either one commodity or one use of a commodity. However, in
real life, a consumer normally consumes more than one commodity. In such a situation, Law of
Equi-Marginal Utility' helps in optimum allocation of his income.
▪ So Condition to fulfil consumer
equilibrium in case of double
commodity

▪ The ratio of Marginal utility to

price is same in case of both
the goods
▪ MU Falls as consumption
increases

▪ A consumer in consumption of
two commodities will be at
equilibrium when he spends his
limited income in such a way that
the ratio of marginal utilities of two
commodities and their respective
prices are equal & MU Falls as
consumption increases.
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'. 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 prices are equal and MU falls as consumption increases. It means,
there are two necessary conditions to attain Consumer's Equilibrium in case of Two Commodities:

(i) 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 be at equilibrium

Mux = Mum
When = Px
𝑴𝒖𝒙 𝑴𝒖𝒚
Muy = Mum Equating 1 and 2, we get:... 𝑴𝑼𝑴 = =
𝑷𝒙 𝑷𝒚
Py
(ii) MU falls as consumption increases:

The second condition needed to attain consumer's equilibrium is that MU of a commodity must fall as more of it is
consumed. If MU does not fall as consumption increases, the consumer will end up buying only one good which is
unrealistic and consumer will never reach the equilibrium position.

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 increases.

Diagrammatic 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 5, which he wishes to spend on two commodities: 'x' and 'y'. Both these commodities are
priced at 1 per unit. So, consumer can buy maximum 5 units of 'x' or 5 units of y.
We have shown the marginal utility which the consumer derives from various units of x' and 'y

Units MU of X in utils MU of Y in utils

1 20 16
2 14 12
3 12 8
4 7 5
5 5 3
What happens when Mux is not equal to Muy
Px Py

Suppose, Mux > Muy

Px Py

In this case, the consumer is getting more marginal utility

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
MU, and rise in Muy. The consumer will continue to buy more of X till Mux = Mux
Px Px
When Mux < Muy
Px Py

the consumer is getting more marginal utility per rupee in case of good Y as compared to X. Therefore, he will buy
more of Y and less of X. This will lead to fall in MUy and rise in Mux . The consumer will continue to buy more of till
Mux = Mux
Px Px

It brings us to a conclusion that Mux = Mux is a necessary condition to attain Consumer's Equilibrium.
Px Px
 If Mux > Muy
Px Py

So in this situation consumer starts purchasing more commodity of X

because it tends to decline in MU of X and then it will became equal to Muy
Py

So under this we will assume that

Mux= Muy

Law of diminishing marginal utility will be followed & Expenditure on X &

Y will be equal to Income

Px*Qx + Py*Qy = Mum (Income)

Assumption
Price = Same
MU is diminishing
 1. Mux= Muy
2. Law of Diminishing Marginal Utility
3. Expenditure on both product will
be equal to money income
available

▪ i.e. Px*Qx + Py*Qy = Mum

ASSUMPTIONS
Unit Mux Muy
1 12 10 ▪ Price of Both product is assumed as 10 Rs

2 10 8 ▪ Total Income = Rs 50

3 8 6 ▪ Mux= Muy

4 6 4 ▪ Bundle
▪ (2,1)= 2*1 + 1*1 = 30
▪ (3,2)= 3*1 + 2*1 = 50
5 4 2 ▪ (4,3)= 4*1 + 3*1 = 70
▪ (5,4)= 5*1 + 4*1 = 90
In the diagram, MU from commodity 'x' is taken on OY-axis and MU from commodity 'y' is taken on OY-axis. MUx
and Muy are the MU curves for commodities 'x' and 'y' respectively.

It is obvious 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. To reach the equilibrium, consumer
should purchase that combination of both the goods,

when:

(1) MU of last rupee spent on each commodity is same; and

(2) MU falls as consumption increases.

It happens at point E when consumer buys 3 units of 'x' and 2 units of 'y' because:

• MU from last rupee (ie. 5th rupee) spent on commodity y gives the same satisfaction of 12 utils as given by last
rupee (i.e. 4th rupee) spent on commodity x; and• MU of each commodity falls as consumption increases. The total
satisfaction of 74 utils will be obtained when consumer buys 3 units of 'x' and 2 unitsof 'y’.

It reflects the state of consumer's equilibrium. If the consumer spends his income in any other order, total
satisfaction will be less than 74 utils.
Limitation of Utility Analysis

In the utility analysis, it is assumed that utility is

cardinally measurable, i.e.,

It can be expressed in exact unit. However, utility is a

feeling of mind and there cannot be a standard
measure of a person feels. So,

Utility cannot be expressed in figures. There are

other limitations too. But, what a their discussion is
beyond the scope.
Units MUx MUy MUx/Px MUy/Py

1 36 40 12 10

2 33 36 11 9

3 30 32 10 8

4 27 28 9 7

5 24 24 8 6

6 21 20 7 5
Assumption, Px = Rs.3, Py = Rs.4
Y = Rs.20 Here, MUm = 9

(b) Ordinal approach (Indifference Curve Analysis): According to this approach utility cannot be measured but can be expressed
in order or ranking.

𝑃𝑥
Condition of Equilibrium = 𝑀𝑅𝑆𝑥𝑦 = [𝑃𝑥 = 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 ′𝑥 ′ 𝑃𝑦 = 𝑃𝑟𝑖𝑐𝑒 𝑜𝑓 ′𝑦 ′ ]
𝑃𝑦

1.or budget line must be tangent to indifference curve.

2.MRS must be diminishing or,

3.Indifference curve must be convex to the origin.

CONCEPTS
▪ Law of equi-marginal utility- It states that when a consumer spends his income on different
commodity he will attain equilibrium or maximize his satisfaction at that point where ratio
between marginal utility and price of different commodities are equal and which in turn is
equal to marginal utility of money.

▪ Budget set :It is quantitative combination of those bundles which a consumer can purchase
from his given income at prevailing market prices.

▪ Consumer Budget :It states the real purchasing power of the consumer from which he can
purchase the certain quantitative bundles of two goods at given price.
Budget Line : A graphical representation of all those
bundles which cost the amount just equal to the consumers
money income gives us the budget line.

Monotonic Preferences :Consumer’s preferences are

called monotonic when between any two bundles, one
bundle has more of one good and no less of other good as it
offers him a higher level of satisfaction.

Change in Budget Line :There can be parallel shift

(leftwards or rightwards) due to change in income of the
consumer and change in price of goods. A rise in income of
the consumer shifts the budget line rightwards and vice-
versa.In case of change in price of one good, there will be
rotation in the budget line. Fall in price cause outward
rotation due to rise in purchasing power and vice-versa
▪ Budget set :It is quantitative combination of those bundles which a consumer can purchase from
his given income at prevailing market prices.
Consumer Budget :It states the real purchasing power of the consumer from which he can
purchase the certain quantitative bundles of two goods at given price.
Budget Line : A graphical representation of all those bundles which cost the amount just equal to
the consumers money income gives us the budget line
Marginal Rate of Substitution (MRS) :It is the rate at which a consumer is willing to substitute
(good Y/ good X) one good to obtain one more unit of the other good. Generally, It is the slope of
indifference curve
𝐿𝑜𝑠𝑠 𝑜𝑓𝐺𝑜𝑜𝑑 𝑌 Δ𝒀
𝑀𝑅𝑆 = 𝑂𝑅
𝐿𝑜𝑠𝑠 𝑜𝑓 𝐺𝑜𝑜𝑑 𝑋 Δ𝑿
INDIFFERENCE ▪ It is a curve showing different
combination of two goods, each

CURVE combinations offering the same

level of satisfaction to the consumer.
▪ Assumptions of IC

▪ Two Commodities :- Since

consumer has fixed amount of
income so he/she has to spent on
two goods at constant price of both
goods

▪ Non- Satiety:- Since consumer has

unlimited wants for satisfaction so
he/she will not more & more
commodities as higher the
indifference curve shows higher
level of satisfaction

▪ Ordinal Utility:- Consumer can rank

his or her satisfaction on the basis of
bundles of goods

▪ Diminishing marginal rate of

substitution:- Since diminishing
marginal rate of substitution
followed so it will diminish and
convex towards the origin

▪ Rational Consumer:- Consumer is

assumed to behave in a rational
manner so he/she aims to maximise
his satisfaction
 PROPERTIES OF IC
▪ Indifference curves are negatively sloped (i.e. slopes
downward from left to right).
▪ Indifference curves are convex to the point of origin. It
is due to diminishing marginal rate of substitution.
▪ Indifference curves never touch or intersect each
other. Two points on different IC cannot give equal
level of satisfaction.
▪ Higher indifference curve represents higher level of
satisfaction.
 MONOTONIC ▪ Consumer’s preferences are called monotonic
when between any two bundles, one bundle has
more of one good and no less of other good as it

PREFERENCE offers him a higher level of satisfaction

INDIFFERENCE MAP
▪ It refers to the family of indifference
curves that represent consumer
preferences over all the bundles of
the two goods

▪ Higher the indifference curve shows

higher level of satisfaction as
higher indifference curve
represents large bundles of goods,
which means more utility because of
monotonic preference.
MARGINAL RATE OF
SUBSTITUTION
▪ Marginal Rate of Substitution (MRS) :It is the rate at
which a consumer is willing to substitute (good
Y/ good X) one good to obtain one more unit of the
other good. Generally, It is the slope of indifference
curve

𝑳𝒐𝒔𝒔 𝒐𝒇𝑮𝒐𝒐𝒅 𝒀 𝜟𝒀
▪ 𝑴𝑹𝑺 = 𝑶𝑹
𝑳𝒐𝒔𝒔 𝒐𝒇 𝑮𝒐𝒐𝒅 𝑿 𝜟𝑿

▪ Marginal Rate of Substitution (MRS) :It is the

rate at which a consumer is willing to substitute
(good Y/ good X) one good to obtain one more
unit of the other good. Generally, It is the slope of
indifference curve.
 MARGINAL RATE OF SUBSTITUTION
▪ Marginal Rate Of Substitution MRS refers to the rate at
which the consumer substitute one good to obtain one
more unit of the other good. The slope of the Indifference
curve is

▪ MRS = Y
X

MRS is never constant, it varies over the IC. As we move

along Indifference Curve, MRS falls also called Diminishing
Marginal rate of substitution.
 Combination Burger Cold Drink MRS of Burger & Cold
Drink

A 1 15 -
B 2 10 5C:1B
C 3 6 4C:1B
D 4 3 3C:1B
E 5 1 2C:1B

MRS BETWEEN BURGER & COLD DRINK

 BUDGET
▪ Consumer Budget:-
A budget constraint represents all the
combinations of goods and services that a
consumer may purchase given current prices
within his or her given income. Consumer
Budget states the real income or purchasing
power of the consumer from which he can
purchase certain quantitative bundles of two
goods at given price. It means, a consumer can
purchase only those combinations (bundles) of
goods, which cost less than or equal to his
income.
BUDGET LINE
▪ Budget Line: A graphical representation of all those
bundles which cost the amount just equal to the
consumer’s money income gives us the budget line. The
budget line represents two different combinations of
goods which a consumer can purchase with the given
income and prices of commodities.
▪ For example;-
▪ Q1 be the amount of Good 1, Q2 be the amount of Good
2, P1 be the price of Good 1, P2 be the price of Good 2,
P1q1 = Total money spent on Good 1, P2q2 = Total money
spent on Good 2. Therefore, the equation of the budget
line will be p1q1 + p2q2 = X. The budget set can be
shown in the below diagram
▪ Budget line always slope downwards so that consumer
can increase the consumption of Good 1 only by
decreasing the consumption of Good 2. If consumers
desire to have one additional unit of Good 1, then they can
only have that additional unit if they manage to give up
some quantity of other good. Consumers have limited
income. They have to decide whether to spend on either
Good 1 or Good 2
BUDGET SET
▪ It is the set of all possible combination of
the two goods which a consumer can afford,
given his income & price in the market.
▪ It includes all the possible bundles which
cost less than or equal to consumer’s
money income at the given prices.
▪ Budget Line represents all those bundles
that the consumer can purchase by
spending his entire income at the given
prices.
▪ Bundles of budget set lie either on or
below the budget line while bundles of
budget line always lie only on the budget
line.
PROPERTIES OF BUDGET
LINE

▪ Budget line is a downward

sloping :- As it has a negative
slope
▪ Budget line is a straight line :-
The slope of budget line is
represented by the price ratio
and price ratio is constant
throughout, the budget line is a
straight line.
▪ Change in Budget Line: There can be parallel shift
(leftwards or rightwards) due to change in income of
the consumer and change in price of goods. A rise in
income of the consumer shifts the budget line
rightwards and vice-versa. In case of change in price
of one good, there will be rotation in the budget line.
Fall in price cause outward rotation due to rise in
purchasing power and vice-versa
CONSUMER EQUILIBRIUM IN
CASE OF INDIFFERENCE CURVE
▪ Consumer equilibrium refers to a situation, in which a
consumer derives maximum satisfaction, with no
intention to change it and subject to given prices and
his given income.

▪ The point of maximum satisfaction is achieved by

studying indifference map and budget line together.

▪ On an indifference map, higher indifference curve

represents a higher level of satisfaction than any lower
indifference curve. So, a consumer always tries to
remain at the highest possible indifference curve,
subject to his budget constraint.

▪ Conditions of Consumer's Equilibrium The consumer's

equilibrium under the indifference curve theory must
meet the following two conditions:
𝑷𝒙
▪ (1) MRS xy = Ratio of prices or
𝑷𝒚

▪ (2) MRS continuously Falls

 𝑷𝒙
(1) MRS xy= Ratio of prices or
𝑷𝒚

(2) MRS continuously Falls

𝑷𝒙
(i) If MRS xy > = it means that to obtain one more unit of X, the consumer is willing to sacrifice more units of Y
𝑷𝒚
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 becomes equal to the ratio of prices and the equilibrium is established.

𝑷𝒙
If MRS xy< , = it means that to obtain one more unit of X, the consumer is willing to sacrifice less units of Y as
𝑷𝒚
compared to what is required in the market. It induces the consumer to buy less of X and more of Y. As a result, MRS
rises till it becomes equal to the ratio of prices and the equilibrium is established.

(ii) MRS continuously falls.

The second condition for consumer's equilibrium is that MRS must be diminishing at the point of equilibrium, Le
the indifference curve must be convex to the origin at the point of equilibrium. Unless MRS continuously falls, the
equilibrium cannot be established.

Thus, both the conditions need to be fulfilled for a consumer to be in a equilibrium.

▪ Let us now understand this with the help of a
diagram:

▪ IC1, IC2 and IC3, are the three indifference

curves and AB is the budget line. With the
constraint of budget line, the highest
indifference curve, which a consumer can reach,
is IC. The budget line is tangent to indifference
curve IC2, at point 'E’.

▪ This is the point of consumer equilibrium,

where the consumer purchases OM quantity of
commodity X and ON quantity of commodity Y.
All other points on the budget line to the left or
right of point 'E' will lie on lower indifference
curves and thus indicate a lower level of
satisfaction.

▪ As budget line can be tangent to one and only

one indifference curve, consumer maximizes his
satisfaction at point E. when both the conditions
of consumer's equilibrium are satisfied:
 𝑷𝒙
▪ (i) MRS = Ratio of prices or -: At tangency point E, the absolute value of the slope of the indifference curve
𝑷𝒚
(MRS between X and Y) and that of the budget line (price ratio) are same. Equilibrium cannot be established at any
other point points
𝑷𝒙 𝑷𝒙
▪ MRS xy > at all points to the left of point E & MRS xy < to the left at right of point E. So, equilibrium is
𝑷𝒚 𝑷𝒚
𝑷𝒙
established at point E, when MRS xy =
𝑷𝒚

▪ (ii) MRS continuously falls: The second condition is also satisfied at point E as MRS is diminishing at point E, i.e.
IC2, is convex to the origin at point E.
CONSUMER
EQUILIBRIUM
▪ Preference of consumer is governed by monotonic
preferences. Monotonic Preferences refers to a
situation, where the consumer will prefer more of a
commodities than the combination providing lesser
commodities. OR A consumer’s preferences are
monotonic if and only if between any two bundles, the
consumer prefers the bundle which has more of at
least one of the goods and no less of the other good
as compared to the other bundle.

▪ Consumer’s Equilibrium: A consumer is said to be

in equilibrium when he maximizes his satisfaction,
given his money income and prices of two
commodity. He attains equilibrium at that point where
the slope of IC is equal to the slope of budget line
EXAMPLES
▪ “The consumer is in equilibrium when he maximises his utility, given his income and the market
prices.”
▪ CONSUMER’S EQUILIBRIUM IN CASE OF SINGLE COMMODITY
▪ Suppose you, as a consumer are buying some ice cream. The price of each unit of the ice cream is ₹
4.The hypothetical MU of that ice cream is given as
▪ As the number of units consumed increase, the marginal utility of the ice cream decreases. The MU of the ice
cream is equal to the price of the ice cream at point E, at which the consumer is in equilibrium.

So, in this case:

Equilibrium : MUx=Px MUx=Px

A consumer is in equilibrium when the Marginal Utility of the ice cream is equal to the price of the ice cream
▪
Consumer – Equilibrium in case of double commodity

Assumptions

1. Mux= Muy
2. Price of both commodity will be same
3. Law of diminishing marginal utility will be followed
4. Expenditure on both product will be equal to the total income
CONSUMER’S EQUILIBRIUM IN CASE OF TWO
COMMODITIES
Suppose that you earn ₹ 30 which you like spending on two commodities:
•Chocolate
•Ice cream
You’ll consume these two in such a way that:
MUx/Px=MUy/Py=MUmMUx/Px=MUy/Py=MUm
or
The marginal utility chocolate at a given price should be equal to the marginal utility of ice cream at a given price
which should be equal to the marginal utility of money.
ASSUMPTIONS:
Let’s go over the assumptions first:
•Consumer is rational
•Utility can be measured in term of money
•MUm is constant
•Only standard unit of commodity are consumed
•Law of Diminishing Marginal Utility applied here
IN ORDER TO DISPLAY THE COMBINATION OF TWO GOODS X AND Y, THAT THE CONSUMER BUYS TO
BE IN EQUILIBRIUM, LET’S BRING HIS INDIFFERENCE CURVES AND BUDGET LINE TOGETHER.
▪ Indifference Map – shows the consumer’s preference scale between various combinations of two
goods
▪ Budget Line – depicts various combinations that he can afford to buy with his money income and
prices of both the goods.
▪ In the following figure, we depict an indifference map with 5 indifference curves – IC1, IC2, IC3, IC4,
and IC5 along with the budget line PL for good X and good Y
▪ From the figure, we can see that the combinations R, S, Q, T,
and H cost the same to the consumer. In order to maximize
his level of satisfaction, the consumer will try to reach the
highest indifference curve. Since we have assumed a budget
constraint, he will be forced to remain on the budget line.
▪ So, which combination will he choose?
▪ Let’s say that he chooses the combination R. From Fig. 1, we
can see that R lies on a lower indifference curve – IC1. He can
easily afford the combinations S, Q, or T which lie on
the higher ICs. Even if he chooses the combination H, the
argument is similar since H lies on the curve IC1 too.
▪ Next, let’s look at the combination S lying on the curve IC2.
Here again, he can reach a higher level of satisfaction within
his budget by choosing the combination Q lying on IC3 –
higher indifference curve level. The argument is similar for
the combination T since T lies on the curve IC2 too
Therefore, we are left with the combination Q.
What happens if he chooses the combination Q?
This is the best choice since Q lies on his budget line and pts puts him
on the highest possible indifference curve, IC3. While there are higher
curves, IC4 and IC5, they are beyond his budget. Therefore, he reaches
the equilibrium at point Q on curve IC3.
Notice that at this point, the budget line PL is tangential to the
indifference curve IC3. Also, in this position, the consumer buys OM
quantity of X and ON quantity of Y.
Since point Q is the tangent point, the
slopes of line PL and curve IC3 are
equal at this point. Further, the slope
of the indifference curve shows a
marginal rate of substitution of X for Y
(MRSxy) equal to MUxMUy. Also, the
slope of the price line (PL) indicates
the ratio between the prices of X and Y
and is equal to PxPy.
Hence, at the equilibrium point Q,
MRSxy = MUxMUy = PxPy

Therefore, we can say that consumers

equilibrium is achieved when the price
line is tangential to the indifference
curve. Or, when the marginal rate of
substitution of the goods X and Y is
equal to the ratio between the prices
of the two goods
CONNSUMER
EQUILIBRIUM QUESTIONS
BY – AM S
IMPORTANT CONCEPTS AND QUESTIONS
▪ 1. Define Marginal Utility and explain law of Diminishing Marginal Utility
▪ 2. Explain the relationship between TU and MU with the help of schedule
▪ 3. A consumer consumes two goods X and Y , Explain the condition of consumer
equilibrium with the help of utility analysis
▪ 4. Explain three properties of Indifference Curve
▪ 5. Explain Consumer Equilibrium in Case of double commodity
▪ 6. Explain Consumer Equilibrium in case of Indifference Curve
▪ 7. Define Marginal Utility and explain law of Diminishing Marginal Utility
Q.2 EXPLAIN THE
RELATIONSHIP
BETWEEN TU AND MU
WITH THE HELP OF
SCHEDULE
Q3. A CONSUMER CONSUMES
TWO GOODS X AND Y ,
EXPLAIN THE CONDITION OF
CONSUMER EQUILIBRIUM
WITH THE HELP OF
UTILITY ANALYSIS
Q.5 EXPLAIN
CONSUMER
EQUILIBRIUM IN
CASE OF
INDIFFERENCE
CURVE
Solution:

Given Px= 3, Py=3 and MRS=3 ,A consumer is said to be in equilibrium when MRS=
Px/Py
Question 1
Define Total Utility.
Ans: Total Utility refers to the total satisfaction obtained from the consumption of all possible units of a commodity.

Question 2
Explain how the Total Utility and Marginal Utility are calculated, by using graphical representation.

Ice Creams Marginal Utility Total Utility (TU)

consumed (MU)
1 20 20
2 16 36
3 10 46
4 4 50
5 0 50
6 -6 44
 Question 3
Explain the Law of Diminishing Utility.
Ans: The Law of Diminishing Utility (LDMU) states that as we consume more and more units of a commodity, the utility derived
from each successive unit goes on decreasing.
Question 4
Mention 4 Assumptions of Law of Diminishing Utility.
Ans: The 4 assumptions of Law of Diminishing Utility are:
• Rational Consumer
• Perfect Knowledge
• Fixed Income and prices
• Independent utilities
Question 5
What is Indifference Curve?
Ans: Indifference Curve refers to the graphical representation of various alternatives combinations of bundles of 2 goods
among which the consumer is indifferent.
Question 6
Expand MRS.
Ans: MRS stands for Marginal Rate of Substitution.
Formulas
TU = U1+ U2 + U3 +…….. Un i.e σ 𝑀𝑈

MUn = 𝑇 ሪ −𝑇𝑈𝑛−1
𝑛

Consumer Equilibrium in Case of single Commodity – MU= Price

𝑴𝑼𝒙 𝑷𝒙 𝑴𝑼𝒙 𝑴𝑼𝒚

Consumer Equilibrium in Case of Double Commodity = 𝐎𝐑 =
𝑴𝑼𝜸 𝑷𝒚 𝝆𝒙 𝑷𝒚
TEST
▪ A consumer consumes only two goods x and y and is in equilibrium. Price of x falls.
Explain the reaction of the consumer through the utility analysis =3
▪ A consumer consumes only two goods x and y. State and explain the conditions of
consumer’s equilibrium, with the help of indifference curve analysis=4
▪ Explain Law of Diminishing Marginal Utility =5
▪ Explain the properties of Indifference curve =3
Where, MU of one rupee refers to the utility obtained from the purchase of commodities with one rupee.
In particular, the condition (a) says that the marginal utility of a product in terms of money should be equal to its price

Sometimes, this is loosely stated as Marginal utility is equal to price, i.e.

MU = Price.
-> If MU > Price
-> As a rational consumer, he keeps on going to purchase an additional unit of a commodity as long as MU = Price.
-> MU > Price implies when benefit is greater than cost and whenever benefit is greater than cost a consumer keeps on
consuming additional unit of a commodity till MU = Price

It is so because according to the law of diminishing marginal utility, MU falls as more is purchased. As MU falls, it is
bound to become equal to the price at some point of purchase.
-> If MU< Price
-> As a rational consumer he would have to reduce the consumption of a commodity as long as MU=Price.
-> MU < Price implies when benefit is less than cost and whenever benefit is less than cost, consumer keeps on
decreasing the additional unit of a commodity till MU = Price

It is so because according to the law of diminishing marginal utility, MU rises as less units are consumed. As MU rises,
it is bound to become equal to the price at some point of purchase.
• Sufficient Condition: Total gain falls as more is purchased after equilibrium. It means that consumer continues to
purchase so long as total gain is increasing or at least constant
Consumption (Units) 0 1 2 3 4
Marginal Utility (Mux) (utils ) - 5 4 3 2
M.U.(rs.)MUX - 5 4 3 2
MUR
Market Price - 3 3 3 3
Marginal Gain - 2 1 0 -1
Total Gain - 2 3(2+1) 3(3+0) 2(3-1)
It can be explained with the help of the following schedule and diagram

Suppose, the price of commodity X in the market is Rs.3 per unit. It means he has to pay Rs.3 per unit. Suppose, the
utility obtained from the first unit is 5 utils (= Rs.5). The consumer will buy this unit because the utility of this unit is
greater than the price. Whether the consumer consumes second unit or not depends on the utility obtained from the
second unit. Suppose, it is 4 utils (= Rs.4). He will buy the second unit also. Again, suppose the utility of the third unit is
3 utils (= Rs.3). The price paid is also Rs.3. Since the utility equals to price he will buy the third unit also. Consumer will
not buy the fourth unit because utility of this unit is 2 utils (= Rs.2) which is less than the price. It is not worth buying
the fourth unit. The consumer will restrict his purchase to only 3 units
The difference between utility and price of a unit of a commodity represents the gain to the consumer from that unit.
For example, utility of first unit of X is Rs.5 and price paid is Rs.3, The gain is Rs.2 (= 5 – 3). Similarly, gain from the
second unit is Rs.1 and from the third unit is zero. The total gain from the three units is Rs.3 (= 2 + 1 + 0). Marginal
Gain from the 4th unit is negative, i.e. -1 (= 2 – 3). Total gain from 4 units is Rs.2 (= 2 + 1 + 0 – 1). The consumer
maximises gain when he buys only 3 units.

The conclusion is that in a single commodity case a consumer makes purchases only upto the point where MU = Price.

In the above diagram, consumption (demand) is recorded on the horizontal axis and marginal utility (price) is recorded
on the vertical axis
THANK YOU
BY – AM S