Consumer’s Equilibrium

Part - II
 CBSE Revised Syllabus 2020 -21

• Indifference curve analysis of consumer's equilibrium-the

consumer's budget (budget set and budget line).

• Preferences of the consumer (indifference curve, indifference

map) and conditions of consumer's equilibrium.
 Meaning of Indifference Curve
Indifference curve refers to the graphical representation of various alternative combinations
of bundles of two goods among which the consumer is indifferent.

Indifferent Schedule

Combinatio Apple (A) Banana

n of apple (B)
and banana
P 1 15
Q 2 10
R 3 6
S 4 3
T 5 1
Explanation of Diagram: In the diagram, apples are measured along
the X – axis and banana on the Y – axis. All points (P, Q, R, S and T)
on the curve show different combinations of apples and bananas.
These points are joined with the help of a smooth curve, known as
indifference curve (IC1).

An indifference curve is the locus of all the points, representing

different combination, that are equally satisfactory to the consumer.

Every point on IC1 represents an equal amount of satisfaction to

the consumer.
 Indifference Map
Indifferent map is the graphical representation of two or more
indifference curves showing the several combination of different
quantities of commodities, which consumer consumes.

IC1 represents the lowest satisfaction,

IC2 shows satisfaction more than that of
IC1 and the highest level of satisfaction
is depicted by indifference curve IC3.
however, each indifferent curve shows
the same level of satisfaction
individually.
 Marginal Rate of Substitution (MRS)
MRS refers to the rate at which the commodities can be substituted with each
other, so that total satisfaction of the consumer remains the same.
For Example: in the example of apple (A) and Banana (B), MRS of ‘A’ for ‘B’, that
the consumer is willing to sacrifice for an additional unit of ‘A’ for ‘B’, MRS of ‘A’ for
‘B’, will be number of units of ‘B’, that the consumer is willing to sacrifice for an
additional unit of ‘A’, so as to maintain the same level of satisfaction.

MRSAB = Units of Bananas (B) willing to Sacrifice

Units of Apples (A) willing to Gain

MRSAB = ΔB ÷ Δ A
MRSAB is the rate at which a consumer is willing to give up bananas for one
more unit of Apple. It means, MRS measures the slope of indifference curve.
 Properties of Indifference Curve
1. Indifference curves are always convex to the origin.

2. Indifference curve slope downwards.

3. Higher Indifference curves represent higher levels of

satisfaction.

4. Indifference curves can never intersect each other.

 Budget Line
Budget line is graphical representation of all possible combinations of two goods
which can be purchased with given income and prices, such that the cost of each
of these combination is equal to the money income of the consumer.

Example: A consumer has an income of Rs 20. He wants to spend it on two

commodities: X and Y and both priced at Rs 10 each. Now, the consumer has three
options to spend his entire income: (i) Buy 2 units of X; (ii) Buy 2 units of Y; (iii) Buy 1
unit of X and 1 unit of Y. It means, possible bundles can be: (2,0); (0,2) or (1,1).

When all these three bundles are represented graphically, we get a downward
sloping straight line, known as ‘Budget Line’. It is also known as price line
 Diagrammatic Explanation of Budget Line
Schedule of Budget Line Budget Line

Combinatio Apples Bananas Money Spent =

n of Apples (A) (B) Income (Rs)
and (Rs 4 (Rs 2
Bananas each) each)
E 5 0 (5x4) + (0x2) = 20
F 4 2 (4x4)+ (2 x2) = 20
G 3 4 (3x4)+(4x2) = 20
H 2 6 (2x4) + (6x2) = 20
I 1 8 (1x4) + (8 x2) = 20
J 0 10 (0x4) + (10 x2) = 20

Every point on this budget line indicates those bundles of apples and bananas, which the
consumer can purchase by spending his entire income of Rs 20 at the given prices of goods.
 Algebraic Expression of Budget Line
The budget line can be expressed as an equation:
M = (PA x QA) + (PB x QB)
Where:
M = Money income;
QA = Quantity of apples (A)
QB = Quantity of bananas (B)
PA = Price of each apple;
PB = Price of each banana.
 Slope of the Budget Line
Slope of the budget line will be number of units of bananas, that the consumer
is willing to sacrifice for an additional unit of apple.

Slope of Budget Line = Units of Bananas (B) willing to Sacrifice = ΔB

ΔA
Units of Apples (A) willing to Gain

Slope of Budget line is equal to ‘Price Ratio’ of two goods.

Price Ratio = Price of X (Px) = Px

Price of Y (Py) Py
 Properties of Budget Line
The two main properties of Budget line are:

1. Budget Line is Downward Sloping.

2. Budget Line is a Straight Line.

 Shift in Budget Line
1. Effect of a Change in the income of Consumer.
 2. Effect of Change in Price (Apples and Banana)

(i) Change in prices of both the (ii) Change in the price of

commodity on X – axis (Apples):
commodities: When price of both the
goods change, then the budget line will
shift. Fall in prices of both the goods
will lead to a rightward shift in budget
line to A1B1. on the other hand, rise in
prices of both the goods will result in
leftward shift in budget line to A2B2.
(iii) Change in the price of commodity on Y – axis (Banana)
 Consumer’s Equilibrium by Indifference Curve Analysis

Consumer equilibrium refers to a situation, in which a consumer

derives maximum satisfaction, with given prices and his given
income.
Conditions of Consumer’s Equilibrium:

(i) MRSxy = Ratio of prices or = Px/Py

(i) MRS continuously falls.

 Let us understand with the help of diagram

IC1, IC2 and IC3 are indifference

curves and AB is the budget line. 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’.
Thanks
Prepared By
Rohitash Kumar
PGT Economics
KV No 1 Colaba