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CONSUMER EQ (Ordinal)
CONSUMER EQ (Ordinal)
This approach assumes that utility or This approach assumes that utility
satisfaction can be measured in terms of cannot be measured but can be
utils. compared i.e., expressed in terms
of ranking.
Assumptions of cardinal approach are Assumptions of ordinal approach
impractical and unrealistic. are practical and realistic
It does not differentiate between inferior and It helps in bringing out the
giffen goods. difference between inferior and
giffen goods.
Used to find equilibrium for single Used to find equilibrium for two
commodity and multiple commodity case commodity case only.
Q3. What are the assumptions on which indifference curve analysis is based?
1. Consumer is rational: it means consumer seeks to maximize utility or satisfaction in
spending his income.
2. Ordinal measurability: It means satisfaction can not be measured but it can be compared.
Consumers can mark his preferences.
3. Monotonic preferences: This assumption means better, more utility i.e., utility is an
increasing function of consumption and this is called monotonic function. The
preferences based on monotonic utility preferences are called monotonic preferences.
This means that as consumption increases total satisfaction increases with it.
Q4. Define indifference curve and give a schedule of IC.
ANS. It is locus of different combinations of two goods the consumer can consume, where
each combination gives same level of satisfaction.
APPLES MANGOES
20 1
15 2
11 3
8 4
6 5
1 definition Definition
2 All the bundles of budget line are a It is a broader concept as it includes all the
part of budget set. feasible combinations where consumer is
spending whole or less than whole
income.
4 as we can see in the graph AB is the As we can see in the graph AOB is the
budget line. budget constraint.
When MRS > Px, it needs to obtain one more unit of good X,
Py
Consumer is willing to sacrifice more good Y than what the market requires. It means consumer
values good X more than what market values. This means gain for the consumer, which induces
him to buy more of good X, this means MU of good X falls. Therefore, consumer is willing to
sacrifices less and less units of good Y as he consumes an extra unit of good X.
MRS continuously falls and becomes equal ratio at some combination of good X and good Y.
This is the consumer equilibrium point.
If MRS < MRE, it means to obtain one more unit of good X consumer is willing to sacrifice less
of good Y as compared to what market requires. It means consumer values good X more than
what market values. So, he will decrease the consumption of good X and increase the
consumption of good Y. MRS starts rising and this continues till MRS = MRE.
2) Second condition ensures that if MRS is not equal to MRE, than falling MRS leads to
equality.
Graphical equilibrium
Let the two goods be X & Y and their prices be Px and Py respectively. Consumer equilibrium is
the level of output where consumer maximizes his satisfaction with the given budget constraint.
In the given figure consumer equilibrium is at the point E where budget line is tangent to
indifference curve i.e.,
where slope of IC = slope of budget line.
Second condition is the slope of IC diminishes i.e.; IC is convex to the origin.
A consumer always tries to remain at the highest IC possible subject to his budget constraint. In
the diagram IC1, IC2 & IC3 are the three indifference curves and AB is the budget line which is
tangent to IC2 at the point E. This is the point of consumer equilibrium is OX of good X and OY
of good Y.
Consumer cannot get satisfaction level higher than IC2 because his income does not permit him
to come above the budget line AB. For example, point C and D on the budget line lie on the
lower IC and gives lesser satisfaction as compared to point E.
As budget line can be tangent to one and only one IC, consumer maximizes his satisfaction at
point E where both the conditions of consumer equilibrium are satisfied.
Graph
b) When price of good X changes – It is assumed that the income of consumer and price of
good Y is given and there is change only in price of good X. When price of good X
decreases, purchasing power of good X increases which means budget line will shift
rightwards on X axis. In case of good X’s price increases, purchasing power of good X
decreases which means budget line will shift leftwards on X axis.