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Consumer Equillibrium, Ankita Joshi
Consumer Equillibrium, Ankita Joshi
Consumer Equillibrium, Ankita Joshi
MEANING OF CONSUMER
A person who buys goods and services for the satisfaction of his/her wants is
called as a consumer. A rational consumer always aims at maximising his/her
satisfaction, given income and prices of goods and services.
MEANING OF UTILITY
Want satisfying power of a commodity is called as Utility.
Utility is the satisfaction derived by a consumer from consumption of a commodity.
MEASUREMENT OF UTILITY
1.Price of the commodity (Px): It is the amount at which commodity is sold in the
market. It is measured in terms of rupees.
2. Marginal Utility of Good (MUx): It is the utility derived from the consumption
of each additional unit of a commodity. It is measured in terms of Utils.
3. Marginal Utility of Money(MUx): It refers to the satisfaction derived per rupee.
(It is assumed to be constant)
MU = MUx /MUx
Assumptions
Consumer is rational
Utility is cardinal in nature
Consumer consumes two goods, X and Y
Income of consumer is fixed
Price of commodity X and Y is constant
ORDINAL APPROACH
Rather, a rational consumer can only rank the commodities based on his/her
preferences.
If there are two combinations available A and B, then Consumer's
Preferences are of three types:
• A consumer will always prefer A over B.
• A consumer will always prefer B over A.
• A consumer is indifferent between A and B that is, both the
combinations provide the consumer with same level of satisfaction.
For Example, if there are two goods available, Pizza and Burger. Then, there will be
some set of individuals who will always prefer pizza over burger, there will be
others who will always prefer burger over pizza. Then, there will be third kind
who can have anything, as they only care about satisfying their hunger. This third
set of preference is called as "Being Indifferent".
CONCEPT OF INDIFFERENCE CURVE
It is a graphical representation of various
possible combinations of two goods that
provide the consumer with same level of
satisfaction.
In the diagram, combinations A, B, C, D are on
the same Indifference curve which means
that they all provide the consumer with same
level of satisfaction.
MONOTONIC PREFERENCES
Monotonic means "More is better”
A rational consumer will always prefer a combination where he gets more of at
least one good and no less of the other.
For Example,
Between combinations A(5, 7) and B(5, 8)Consumer will always prefer bundle
B as he is getting more of Y and same units of X.
Between combinations A(5, 7) and C(6, 7): Consumer will always prefer
bundle C as he is getting more of X and same units of Y.
A(5, 7) and D(6, 8): Consumer will always prefer bundle D as he is getting more
of both X and Y.
It is due to monotonic preferences that farther the IC is from origin, higher is
the level of satisfaction.
MARGINAL RATE OF SUBSTITUTION (MRS)
Marginal means "additional". Rate of substitution means "ratio in which units
of one good are substituted with units of another good".
It refers to the rate at which consumer is willing to substitute units of one good
with units of the other good to remain on same level of satisfaction.
No. of units of a good sacrificed
MRSxy =
No. of units of a good gained
ΔY
MRSxy =
ΔX
ΔY = Change in number of units sacrificed
ΔX = Change in number of units gained
It is called as slope of Indifference curve.
MRS should fall continuously. (It means that ICs should be convex to origin)
Disequilibrium Cases
𝐏𝐱
Case I: MRSxy > (Point A)
𝐏𝐲
a) It means that consumer is willing to sacrifice more units of Good Y for an
additional unit of X as compared to the market.
b) A rational consumer will therefore, increase the consumption of X and
decrease the consumption of Y.
c) MRS will fall due to operation of Law of DMU
Px
d) This happens till the time MRSxy =
Py
𝐏𝐱
Case II: : MRSxy < (Point B)
𝐏𝐲
a) It means that consumer is willing to sacrifice less units of Good Y for an
additional unit of X as compared to the market.
b) A rational consumer will therefore, increase the consumption of Y and
decrease the consumption of X.
c) MRSxy will rise due to operation of Law of DMU.
Px
d) This happens till the time MRSxy =
Py
• Consumer cannot be in equilibrium on points A and B as both of them represent
the disequilibrium cases.
• Consumer cannot be in equilibrium on IC3, as it is not affordable by given income
and prices.
Thus, consumer will be in equilibrium on point E where budget line is tangent to
Indifference curve. (Tangent means that the slope of indifference curve MRS is equal
to the slope of budget line)
Basis Cardinal Utility Analysis Ordinal Utility Analysis
1.Concept Utility is measurable and Utility is a psychological
quantifiable concept. concept
2.Expressed in Utility is expressed Utility is expressed in terms
numerically in utils of ranking
3.Propounded by Given by Prof. Alfred Marshall Given by Prof. J.R. Hicks
Px falls MUx
>
MUy • Increase good x
Px Py • Decrease good y
Px rises MUx
<
MUy • Decrease good x
Px Py • Increase good y
Py falls MUx
<
MUy • Decrease good x
Px Py • Increase good y
Py rises MUx
>
MUy • Increase good x
Px Py • Decrease good y
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