CLASS 11 ECONOMICS EDUMANTRA SUPER-NOTES (Full Chapter-2) EDUMANTRA

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CONSUMER’S EQUILIBRIUM

Consumer:
A consumer is one buys goods and services for satisfaction of wants.

Equilibrium:

Equilibrium means a state of rest where there is no tendency to change.

A consumer is said to be equilibrium when he doesn’t intension to change
the level of consumption i.e. when he derives maximum satisfaction.

There are two main approaches to study consumer’s behaviour:

1. Cardinal Utility Approach (given by Alfred Marshall).

2. Ordinal Utility Approach (given by R.G. Allen and J.R. Hicks).

Cardinal Utility Approach:

Under Cardinal Utility Approach, the concept of “Utility” is used to
attain Consumer’s Equilibrium.

Concept of Utility:
Utility is the wants satisfying power of a commodity. It defers person-
to-person, place-to-place and time-to-time.
It can be measured in util. They are imaginary psychological units which
are used to measure utility.
Utility can be measured in monetary terms (money/price) which the
consumer willing to pay.
Example: an ice-cream worth Rs10 and chocolate Rs20. This is known
as value of utility in terms of money.

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Utility is divided into two types:

1. Total utility:
Total utility refers to total satisfaction obtained from the
consumption of all possible units of a same commodity.
It can be calculated as:
TU n = U1 + U2 + U3 +------- + U n

Where:
TU n = total utility from n units of a given commodity.

U1, U2, U3,…..Un = utility from 1st , 2nd , 3rd ……… nth unit

n = number of units consumed.

2. Marginal utility:
It refers to additional utility derive from the consumption of one
more commodity of the given commodity.
MU can be calculated as:
MU = Change in total utility

Change in number of units

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The concept of TU and MU can be better understood from the following

schedule and diagram:

Ice-creams Marginal utility Total utility

consumed (MU) (TU)
1 20 20
2 16 36
3 10 46
4 4 50
5 0 50
6 -6 44

Units of ice-cream, are shown on the X-axis and TU and MU are

measured on the Y-axis.

MU is positive and TU is increasing till the 4th ice-cream. After

consuming the 5th ice-cream, MU is zero and TU is maximum. This point
is known as the point of satiety or the stage of maximum satisfaction.

After the 6th ice-cream, MU is negative (known as disutility) and total

utility starts diminishing.

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Y Maximum TU

50-

Total Utility of 40- TU

Ice Cream
30-

20-

10-

X
O
1 2 3 4 5 6

Units of Ice cream

20 -

16 -
Marginal utility
12 -
of Ice Cream
Zero MU
8 -

4 -

X
O 1 2 3 4 5 6 _ ve MU
-4 _
Units of Ice-Cream
-8 _ MU Curve

Y’

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Relationship between TU and MU:

1. TU increases with an increase in consumption of a commodity as

long as MU is positive, i.e., till the 4th ice-cream. In this phase, TU
increases, but a diminishing rate as MU from each successive unit
tends to diminish.
2. When TU reaches its maximum, MU becomes zero, i.e., when 5th
ice-cream is consumed. This is known as point of satiety. TU curve
stops rising at this stage.
3. When consumption is increased beyond the point of satiety, TU
starts falling as MU becomes negative.

Law of Diminishing Marginal Utility:

This law states that as we consume more and more units of commodity,
the utility derived from each succession unit goes on decreasing.

Assumptions:

i. Continuous consumption
ii. No change in the quality
iii. Independent utility
iv. Fixed income price
v. Perfect knowledge

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Diagrammatic explanation of Law of DMU:

Units of Ice-cream Total Utility Marginal Utility

(in utils) (in utils)
1 20 20
2 36 16
3 46 10
4 50 4
0 (point of satiety)
5 50
6 44 -6

Law of Diminishing Marginal Utility

MU Curve slope downward, indicating decrease in

20 A satisfaction with each successive ice cream

16 - B
16
Marginal Utility of 12 -
Ice- Cream C
8 - Zero MU (point of satiety)

4 - D

E
X
O
1 2 3 4 5 6
Negative MU
˗4 Units of Ice-Cream
_̄
MU
-5 _̵

Y’

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Consumer’s Equilibrium:

A consumer is said to be equilibrium when he does not intend to change

his level of consumption.

Consumer equilibrium can be discussed under two conditions:

1. When consumer spends his entire income on a single commodity.

2. When consumer spends his entire income on two or more
commodities.
 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.
 To determine equilibrium point, a consumer compare the price of
the given commodity with its marginal utility.
 Equilibrium condition is MU x = P x consumer will be at equilibrium
when MU equals to the Price of commodity.

Disequilibrium condition:

 When MU x is greater than to its price. The consumer will purchase

commodity x, so its marginal utility decline due to increase in
consumption, this process is continue.
MU x > P x
 When MU x is lesser than its price, the consumer will have to
reduce the consumption of a commodity x to raise its total
satisfaction till the marginal utility become equal to its price.
MU x < P x
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Consumer’s equilibrium in case of single commodity:

Unit (x) Price (P x) MU MU in Difference Remarks

(MU x ) MU x and P x
1util=Rs.1
1 10 20 20 ÷1= 20 20 -10 = 10 MU x > P
x,
2 10 16 16 ÷1= 16 16 ˗10 = 6 So consumer
will increase
the
consumption.
3 10 10 10 ÷ 1=10 10 ˗ 10 = 0 Consumer’s
Equilibrium
(MU x=P x)
4 10 4 4 ÷ 1 = 4 4 ˗ 10 = ˗6 MU x < P x,
so
5 10 0 0 ÷1= 0 0 ˗ 10= ˗10 Consumer
will decrease
6 10 ˗6 ˗6 ÷ 1= ˗6 ˗6 ˗ 10 = ˗16 the
consumption

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Y Consumer’s Equilibrium in case of single

commodity (X)

MU and Consumer’s Equilibrium (MU x = P x)

Price of 20 -
commodity 16 -
X (in RS.)
12 - Px
8 -
Zero MU (Point of Satiety)
4 -

X
O 1 2 3 4 5 6
-4 -
Units of commodity X
-8 - MU x

Y’

Ordinal Utility Approach:

According to J.R. Hicks and Allen, a consumer can rank various

combinations of goods and services in order to his preference. This
approach reject the psychological phenomenon of ‘cardinal measure of
utility’.

Example: If a consumer consumes two goods, i.e. Apples and Bananas,

then he can indicate:
#whether he prefers Apple over Banana; or
#whether he prefers Banana over Apple;
#whether he is indifferent between Banana and Apple i.e. both give the
same level of satisfaction.

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Indifference Curve:

It refers to the graphical presentation of various possible combination of

two goods that gives same satisfaction to the consumer.

Consumer Equilibrium in case of two commodity:

It depends on the law of equilibrium MU, according to the equilibrium

marginal utility, a consumer get maximum satisfaction where ratio of
MU of two commodities and their prices are equal.
MU falls on as consumption utility.

MU X ̳ MU Y ̳ MU M

P X P Y

For commodity (x) For commodity (y)

MU x ̳ MU m MU y ̳ MU m
Px P y

Equation 1 and 2, we get: MU x ̳ MU y ̳ MU m

Px P y
OR MU x ̳ P x Equilibrium state

MU y P y

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Ques.1 A consumer consumed only two goods x and y. The consumer

have a combination of two goods with marginal utility of x equal to 30
and that of y equal to 20. The price of x is 6 per unit then what will be
the price of y at the equilibrium state?

Ans. Given,

MU x = 30, MU y = 20, P x = 6, P y =?

MU x = MU y = 30 = 20

P x Py 6 P y

= 30×P y = 20×6 P y = 20×6 = 4 P y = 4

30
In this situation, the consumer will purchase both of commodity x and
less of commodity y. So that, MU x will decline and MU y raise. The
consumer will continue become equal to:
MU x ̳ MU y
Px P y

Marginal Rate of Substitution (MRS):

It is the rate at which the commodity can be substituted with each

other. So that, total satisfaction of consumer remain constant.

MRS ̳ Unit of B (sacrifice) ̳ B

Unit of A (gain) A

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MRS between Apple and Banana

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

MRS between Apple and Banana

IC1 is convex shaped due to

P (1A+ 15 B) diminishing MRS

15
5B
12 - Q (2A+ 10B)

Bananas 9 - 4B R (3A+ 6B)

6 - 3B S (4A + 3B)

3 - T (5A+ 1B)
2B
1B IC1

O 1 2 3 4 5
Apples

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Why MRS diminishes?

MRS fall along the slope of indifference curve because of diminishing

marginal utility. When a consumer is willing to give more Banana for an
additional unit of Apple his marginal utility of Banana is increased and
this MU for Apple will keep on decline. As, he is consumed more and
more unit of Apples, as a result he is willing to give less and less Banana
for each unit of Apple.
Properties of Indifference Curve:

1. Indifference curve is convex to origin because of diminishing

marginal rate of substitution.
2. Indifference Curve slopes downward because of consumption of one
commodity, the consumption for other commodity decreases.
3. Higher Indifference Curve gives higher satisfaction because of more
commodities consumed.
4. IC can never intersect because two IC never give the same level of
satisfaction.

Indifference curve IC1 and

IC2 can never intersect each
other

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Monotonic preference:

It means that a rational consumer always prefers more of that

commodity as it offer him a higher level of satisfaction.

Budget line:

It is a graphical presentation of all combination of goods which can be

purchased with given income and price.
Such that cost of the combination is equal to the money of the
consumer.

Example, suppose that, the income of the consumer is Rs.20. Commodity

x equals to Rs.10 and commodity y is also equals to Rs.10.

Three possible combinations are (1,1); (2,0); (0,2).

Income = 20
X = 10, y = 10

10 + 10 = 20
10×1+10×1=20
(1,1)
When all these combination are represented graphically, we get a
downward sloping straight line known as Budget line.

Suppose income of consumer is Rs.20, price of Apple isRs.4, price of

Banana is Rs.2.

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Schedule of Budget line:

Combination of Apples (A) Bananas (B) Money spent=Income

Apples/Bananas (Rs.4 each) (Rs.2 each)

E 5 0 (5×4)+(0×2)=20
F 4 2 (4×4)+(2×2)=20
G 3 4 (3×4)+(4×2)=20
H 2 6 (2×4)+(6×2)=20
I 1 8 (1×4)+(8×2)=20
J 0 10 (0×4)+(10×2)=20

Budget Line

X C

B Unattainable
J Combination
10 -
I
Point ‘D’ indicate that
8 -
H income is underspent
6 -
G
4 - D
Bananas (B) 2 - F
Point ‘D’ indicates
that income is E
underspent
O 1 2 3 4 5 A
Apples (A)

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Shift in Budget line:

Due to change in the income of the consumer and due to change in the
price of both commodity.

Effect of change in income of consumer:

Increase in income leads to rightward shift in the budget line whereas
decrease in income leads to leftward shift.
Y
 Rightward Shift: Budget Line shift
to the right from AB to A1B1 due
to increase in income

 Leftward Shift: Budget Line

shift to the left from AB to A2B2
due to decrease in income
Bananas (B)

X
O A2 A A1

Apples (A)

Effect of change in prices of commodity:

i. Increase in the prices of Apple will shift the budget line leftward.
ii. Decrease in prices of Apple will shift the budget line rightward.
iii. Increase in the prices of Banana will shift the budget line leftward
and decrease in prices will shift rightward.

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Y Change in Price of Apples

Budget Line shift from AB to A1B due to

decrease in price of Apples
Budget Line shift from AB to A2B due to
increase in price of Apples
Bananas (B)

X
O A2 A A1

Apples (A)

Change in price of Bananas

Budget Line shift from AB to AB1 due to

decrease in price of Bananas
B1
Budget Line shift from AB to AB2 due
B to increase in price of Bananas

B2

Bananas (B)

X
O Apples (A) A

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