Class 11 Microeconomics

 A consumer is one who buys

Consumer goods and services for the
satisfaction of wants.
 He takes decisions with regard
to the kind of goods to be
purchased in order to satisfy his
wants.
 The main objective is to get
maximum satisfaction from
spending his income on various
goods and services.
 Approaches which are Used to Study Consumer‟s Behaviour

There are two main approaches to

studying consumer‟s behaviour and
consumer‟s equilibrium are :

Cardinal Utility Approach Ordinal Utility Approach

(or Marshall‟s Utility (or Indifference Curve
Analysis or Marginal Analysis or Hicksian
Utility Analysis). Analysis).
Cardinal
Utility People consume different goods
Approach and services in order to maximize
their satisfaction level. However,
to do this, it is necessary to
determine quantum of
satisfaction obtained from a
particular commodity. Under the
Cardinal Utility Approach, the
concept of “Utility” is used to
attain the consumer‟s equilibrium.
 Utility
 Utility refers to want satisfying power of a commodity. It is the satisfaction, actual or expected, derived from the
consumption of a commodity. Utility differs from person to person, place to place and time to time. In the words of
Prof. Hobson, “Utility is the ability of a good to satisfy a want.”
 There was no standard unit for measuring utility. So, economists derived an imaginary measure known as „Util‟.
Example : Measurement of satisfaction in utils.
Suppose you have just eaten an ice-cream and a chocolate. You agree to assign 20 utils as utility
derived from the ice-cream. Now the question is : how many utils be assigned to the chocolate?
If you liked the chocolate less, then you may assign utils less than 20. However, if you liked it
more, you would give it a number greater than 20. Suppose, you assign 10 utils to the chocolate,
then it can be concluded that you liked the ice-cream twice as much as you liked the chocolate.
 Utility can also be measured in terms of money or price, which the consumer is willing to pay.
 The advantage of using monetary values instead of utils is that it allows easy comparison between utility and price
paid, since both are in the same units.
Example : In the above example, suppose 1 util is assumed to be equal to ₹ 1. Now, an ice-cream will yield utility
worth ₹ 20 (as 1 util = ₹ 1) and chocolate will give utility of ₹ 10. This utility of ₹ 20 from the ice-cream of ₹ 10 from
the chocolate is termed as value of utility in terms of money.

It is impossible to measure the satisfaction of a person as it is inherent to the individual and differs greatly from
person to person. Still, the concept of utility is very useful in explaining and understanding the behaviour of
consumer.
Total Utility :
 Total utility refers to the total satisfaction obtained from the consumption of all
possible units of a commodity.
 It measures the total satisfaction obtained from the consumption of all the units of that good.
 Total utility is zero at zero level of consumption.
 TU = ∑ MU
 If the 1st ice-cream gives you a satisfaction of 20 utils and 2nd one gives 16 utils, then TU from 2 ice-creams is
20 + 16 = 36 utils. If the 3rd ice-cream generates satisfaction of 10 utils, then TU from 3 ice-creams will be 20 +
16 + 10 = 46 utils.
TU can be calculated as : TUn = U1 + U2 + U3 +..… + Un

Marginal Utility :
 MU is the additional utility derived from the consumption of one more unit of the given commodity.
 It is the utility derived from the last unit of a commodity purchased.
∆𝑇𝑈
 MU = ∆𝑄 OR MU = TUn – TUn-1
 As per given example, when 3rd ice-cream is consumed, TU increases from 36 utils to
46 utils. The additional 10 utils from the 3rd ice-cream is the MU.
MU of 3rd ice-cream will be : MU3 = TU3 – TU2 = 46 – 36 = 10 utils

Average Utility :
 AU refers to the per unit satisfaction obtained from the consumption of the particular commodity.
𝑇𝑈
AU = 𝑄
 Relationship Between TU And MU
Units Marginal Utility (MU) Total Utility (TU) Y
Maximum TU

Total Utility from Ice cream

1 20 20 50 TU
2 16 36 40

3 10 46 30

4 4 50 20

5 0 50 10
X
6 -6 44 O 1 2 3 4 5 6
Units of Ice cream
Y

Explanation :

Marginal Utility from Ice cream

50
 TU increases with an increase in consumption of a 40
commodity as long as MU is positive. 30

 When TU reaches its maximum, MU becomes zero. This 20

Zero MU
is known as the ‟Point of Satiety‟. TU curve stops rising 10
X
at this stage. O 1 2 3 4 5
Units of Ice cream
6
-ve MU
-4
 When consumption is increased beyond the point of -8
MU

satiety, TU starts falling as MU becomes negative.

Y‟
 Law of
„Diminishing  Law of DMU states that as we consume more and more
units of a commodity, the utility derived from each
Marginal Utility‟ successive unit goes on decreasing.
 For example : Suppose your father has just come from
work and you offer him a glass of juice. The first glass of
juice will give him great satisfaction. The satisfaction with
the second glass of juice will be relatively lesser. With
further consumption, a stage will come, when he would
not need any more glass of juice, i.e. when the marginal
utility drops to zero. After that point, if he is forced to
consume even one more glass of juice, it will lead to
disutility. Such a decrease in satisfaction with
consumption of successive units occurs due to 'law of
diminishing marginal utility'.
 Law of DMU has universal applicability and applies to all
goods and services.
 It is also known as Gossen‟s first law of consumption as it is
given by a German H.H. Gossen.
 Assumptions of the Law of DMU
Cardinal  It is assumed that utility can be measured
Measurement of and a consumer can express his satisfaction
Utility in quantitative terms such as 1, 2, 3 etc.
Monetary Measurement  It is assumed that utility is measurable
of Utility in monetary terms.
 It is assumed that a reasonable quantity of the
Consumption of
commodity is consumed.
Reasonable
 To hold the law true, a suitable and proper quantity of
Quantity
the commodity should be consumed.
Continuous Consumption  It is assumed that consumption is a continuous process.
 It is assumed that the quality of the
No Change in Quality
commodity is uniform.
  The consumer is assumed to be rational who measures, calculates
Rational Consumer and compares the utilities of different commodities and aims at
maximizing total satisfaction.

 It is assumed that all the commodities consumed by a consumer are

independent i.e. MU of one commodity has no relation with the MU of another
Independent
commodity.
Utilities  Further, It is also assumed that one person‟s utility is not affected by the
utility of any other person.

 As a consumer spends money on the commodity, he is left with lesser money to

spend on other commodities. In this process, the remaining money becomes
MU of Money dearer to the consumer and it increases MU of money for the consumer.
Remains Constant  But, such an increase in MU of money is ignored. As MU of a commodity has to
be measured in monetary terms, it is assumed that MU of money remains
constant.
 It is assumed that income of the consumer and prices of goods remain
Fixed Income and Prices
constant.
 It is assumed that the consumer knows the different goods on which his income
can be spent and the utility that he is likely to get out of such consumption.
Perfect Knowledge
 It means, that the consumer has perfect knowledge of the various choices
available to him.
 Law of DMU
Units of Ice-Cream Total Utility (in units) Marginal Utility (MU)
1 20 20
2 36 16
3 46 10 Law of Diminishing
4 50 4 Y Marginal Utility
5 50 0 (Point of Satiety) A

Marginal utility of Ice cream

20
6 44 -6 B
16

Explanation : 12 C Zero MU

 In the above diagram, units of ice cream are shown along X-axis and 8
D
(Point of Satiety)
MU along the Y-axis. 4
E
 The rectangles (showing each level of satisfaction) become smaller and 5
X
6  Negative MU
O 1 2 3 4
smaller with an increase in the consumption of ice creams. -4
 MU falls from 20 to 16 and then to 10 utils when consumption is -8
MU
increased from 1st to 2nd and then to 3rd ice-cream. Units of Ice Cream
 When 5th is consumed MU = 0 and this point is known as the „Point of
Y‟
Satiety‟.
 When 6th ice cream is consumed, MU becomes negative.
 MU curve slopes downwards showing that the MU of successive units is
falling.
 More about the Law of DMU
MU may Increase Initially
 In certain situations, MU may increase but it all
depends on the circumstances.
 Economists normally assume that MU continuously falls.

No Indication about the Rate of Fall in MU

 It just states that MU falls with an increase in the
consumption of a given commodity.

Synonyms of the Law of DMU

 It is also known as the „Fundamental Law of Satisfaction‟
or „Fundamental Psychological Law‟.
 Consumer‟s Equilibrium
 Equilibrium means a state of rest or a position of no change.
 A consumer is said to be in equilibrium, when he does not intend to change his level of consumption, i.e., when
he derives maximum satisfaction.
 Consumer 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.
 A rational consumer aims to balance his expenditure in such a manner, so that he gets maximum satisfaction
with minimum expenditure.

Consumer Equilibrium can be discussed under two different situations :

If the consumer spends his entire income on a single

commodity (single commodity approach).
If a consumer spends his entire income on two
commodities (two commodity approach).
 Single Commodity Approach
All the assumptions of the Law of DMU are taken as
assumptions of the consumer‟s equilibrium in the case of a
single commodity.
The number of units to be consumed of the given
commodity by a consumer depends on two factors :

Price of the Given Commodity.

Expected Utility (Marginal Utility)
from each successive unit.
A consumer in consumptions of single commodity will be at equilibrium when
marginal utility (MUX) is equal to the price paid (Px) for the commodity i.e. MUx=PX.
 Case 1  If MUx > Px then the consumer is not at
equilibrium and he goes on buying because the
benefit is greater than the cost.
 As he buys more, MU falls because of the
operation of the law of diminishing marginal
utility. When MU becomes equal to the price,
consumer gets the maximum benefits and is in
equilibrium.
 If MUx < Px then also consumer is not at
equilibrium as he will have to reduce
consumption of commodity x to raise his
Case 2
total satisfaction till MU becomes equal to
price.
 Consumer‟s Equilibrium in Case of Single Commodity
Units Price MU Difference MUx &
MUx = 1 util = ₹ 1 Remarks
x Px (utils) Px
1 10 20 20 ÷ 1 = 20 20 – 10 = 10 MUx > Px
MUx > Px
2 10 16 16 ÷ 1 = 16 16 – 10 = 6 So, Consumer will increase the consumption

Consumer‟s Equilibrium
3 10 10 10 ÷ 1 = 10 10 – 10 = 0 Y Consumer’s Equilibrium in case
(MUx = Px)
of Single Commodity (x)
4 10 4 4÷1=4 4 – 10 = - 6 MUx < Px

MU and Price of commodity X

MUx < Px 20
5 10 0 0÷1=0 0 – 10 = -10 Consumer‟s Equilibrium (MUx = Px)
MUx < Px 16
6 10 -6 -6 ÷ 1 = - 6 -6 – 10 = - 16 So, Consumer will decrease the consumption
12 E

Explanation : 8
Zero MU (Point of Satiety)
 From the above schedule and diagram, it is clear that the consumer will be at 4
equilibrium at point „E‟ when he consumes 3 units, because at point „E‟, MUx = X
O 1 2 3 4 5 6
P X.
-4
-
 A consumer will not consume 4 units as MU of Rs. 4 is less than the price paid -8 MUx
of Rs. 10
Units of commodity X
 Similarly, he will not consume 2 units as MU of Rs. 16 is more than the price
Y‟
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
(MUx) is equal to price (Px) paid for the commodity.
 Two Commodity Approach
 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.
 It is also known as Gossen‟s Second Law and the Law of maximum satisfaction.
 According to this approach, a consumer gets maximum satisfaction when ratios of MU of two
commodities and their representative prices are equal and MU falls as consumption increases i.e.

MUx MUy
=
Px Py

There are two necessary conditions to attain consumer‟s

equilibrium in the case of two commodities :

1) The ratio of Marginal Utility to Price is the same in the case of both
the goods.
MUx MUy
=
Px Py
2) 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.
𝐌𝐔𝐱 𝐌𝐔𝐲
 If > then the consumer is getting more MU in the case of good X as compared to
Case 1
Case 1:
𝐏𝐱
good Y.
𝐏𝐲

 Therefore, he will buy more of X and less of Y.

 This will lead to fall in MUx and a rise in MUY.
𝐌𝐔𝐱 𝐌𝐔𝐲
 The consumer will continue to buy more of X till 𝐏𝐱 becomes equal to 𝐏𝐲

𝑀𝑈𝑥 𝑀𝑈𝑦
 If < then the consumer is getting more MU per rupee in case of good Y as
𝑃𝑥 𝑃𝑦
compared to good X.
Case 2
 Therefore, he will buy more of Y and less of X.
 This will lead to falling in MUY and a rise in MUx.
𝑀𝑈𝑥 𝑀𝑈𝑦
 The consumer will continue to buy more of Y till 𝑃𝑥 becomes equal to 𝑃𝑦 .

Conclusion :
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
Lest 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‟. In Table, we
have shown the marginal utility which the consumer derives from various units of
„x‟ and „y‟.

Consumer’s Equilibrium in case of Two Commodities

Units MU of commodity „x‟ (in utils) MU of commodity „y‟ (in utils)
1 20 16
2 14 12
3 12 8
4 7 5
5 5 3
Explanation :
 From Table, 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 :
a) MU of last rupee spent on each commodity is same; and
b) MU falls as consumption increases.
 It happens at point E when consumer buys 3 units of 'x'
and 2 units of 'y' because :
a) MU from last rupee (i.e. 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
b) 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 units of '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.
Ordinal Utility
 Indifference Curves was made by J.R. Hicks and
Approach R.G.D. Allen, popularly known as Hicks and Allen. In
1934, they wrote an article, „A reconstruction of the
theory of value‟, presenting the Indifference Curve
Analysis.
 Modern economists disregarded the concept of the
„cardinal measure of utility‟. They were of the
opinion that utility is a psychological phenomenon
and it is next to impossible to measure utility in
absolute terms.
 According to them, a consumer can rank various
combinations of goods and services in order of his
preference.
 A method of ranking the preferences is known as the
„ordinal utility approach‟. Ordinal utility is the
utility expressed in ranks.
 Indifference Curve
 Indifference Curve refers to the graphical representation of various alternative combinations of bundles of two
goods among which the consumer is indifferent.
 It is a locus of points that show such combinations of two commodities which give the consumer the same
satisfaction.
Combination of Apples and Bananas Apples (A) Bananas (B)
P 1 15
Q 2 10 Y
Indifference Curve
R 3 6
S 4 3
T 5 1 15 P (1A + 15B)

Explanation : 12
Q (2A + 10B)
 As seen in the schedule, consumer is indifferent between five

Bananas (B)
9
combinations of apple and banana. R (3A + 6B)
 Combination „P‟ (1A + 15B) gives the same utility as (2A + 10B), (3 6
S (4A + 3B)
A + 6 B) and so on. 3 T (5A +1)
 By joining these points, we get an indifference curve IC1 IC1
 MRS is the slope of the Indifference Curve. O
X
1 2 3 4 5
 Every point on IC1 represents an equal amount of satisfaction to Apples (A)
the consumer.
 Monotonic  It means that a rational consumer always
Preferences prefers more of a commodity as it offers him a
higher level of satisfaction.
 It implies that as consumption increases total
utility also increases.

For Example : Consider 2 Goods : Apples (A) and Bananas (B).

a) Suppose two different bundles are: 1st : (10 A, 10 B) and 2nd: (7 A, 7 B).
Consumer‟s preference of 1st bundle as compared to the 2nd bundle will be called
monotonic preference as 1st bundle contain more of both Apples and Bananas.
b) If 2 bundles are: 1st : (10 A, 7 B) and 2nd: (9 A, 7 B).
Consumer‟s preference of 1st bundle as compared to the 2nd bundle will be called
monotonic preference as 1st bundle contains more of apples, although bananas
are same.
 Indifference Map
 It refers to the family of indifference curves that represents consumer preferences
over all the bundles of two goods.
 It represents all the combinations which provide the same level of satisfaction.
 Every higher or lower level of satisfaction can be shown on different indifference
curves.

Y Indifference Map
Explanation :
 IC1 represents the lowest satisfaction, IC2 shows
satisfaction more than that IC1 and the highest level of
satisfaction is depicted by indifference curve IC3.
Commodity Y

P
A B  However, each indifference curve shows the same level of
IC3
IC2 satisfaction individually.
IC1
 Higher Indifference Curves represent higher levels of
X
satisfaction as higher indifference curve represents larger
O R S bundles of goods, which means more utility because of
Commodity X
monotonic preference.
 „Marginal Rate of Substitution‟
It refers to the rate at which the commodities can be Y
MRS between Apple and Banana
substituted with each other so that the total satisfaction IC1 is convex shaped due to
of the consumer remains the same. 15 P (1A + 15B) diminishing MRS

5B {

Bananas (B)
12
Q (2A + 10B)
Combination Apple (A) Banana (B) MRSAB
P 1 15 ----
9
4B { R (3A + 6B)
6
Q 2 10 5B : 1A 3B { S (4A + 3B)

R 3 6 4B : 1A
3
2B { 1B{ T (5A +1)
IC1
X
S 4 3 3B : 1A O 1 2 3 4 5
Apples (A)
T 5 1 2B : 1A

Explanation :
 As seen in the above schedule and diagram, as the consumer moves from P to Q, he sacrifices 5 bananas for 1 apple and MRS comes
out to be 5:1. Similarly, from Q to R, MRSAB is 4: 1.
 The MRS of apples for bananas is diminishing.
 MRS measures the slope of the indifference curve.
𝐔𝐧𝐢𝐭𝐬 𝐨𝐟 𝐁𝐚𝐧𝐚𝐧𝐚𝐬 𝐁 𝐰𝐢𝐥𝐥𝐢𝐧𝐠 𝐭𝐨 𝐬𝐚𝐜𝐫𝐢𝐟𝐢𝐜𝐞 ∆𝐁
 MRSAB = OR MRS =
𝐔𝐧𝐢𝐭𝐬 𝐨𝐟 𝐀𝐩𝐩𝐥𝐞𝐬 𝐀 𝐰𝐢𝐥𝐥𝐢𝐧𝐠 𝐭𝐨 𝐠𝐚𝐢𝐧 ∆𝐀
 MRS diminishes because of the Law of DMU.
 In the given example of apples and bananas, Combination „P‟ has only 1 apple and, therefore, apple is relatively more important
than bananas. Due to this, the consumer is willing to give up more bananas for an additional apple. But as he consumes more and
more of apples, his marginal utility from apples keeps on declining. As a result, he is willing to give up less and less of bananas for
each additional apple.
 Assumptions and Properties of the Indifference Curve
Two Commodities
 It is assumed that the consumer has a fixed amount of money, whole of which
is to be spent on the two goods, given constant prices of both the goods.
Non-Satiety
 It is assumed that the consumer has not reached the point of saturation.
Consumer always prefer more of both commodities.
Ordinal Utility
 Consumers can rank their preferences based on the satisfaction from each bundle of goods.
Diminishing Marginal Rate of Substitution
 Indifference curve analysis assumes diminishing marginal rate of substitution, due to this
assumption, an indifference curve is convex to the origin.
Rational Consumer
 The consumer is assumed to behave in a rational manner, i.e. he aims to maximize his total
satisfaction.
 Properties of Indifference Curve
1) Indifference Curves are Always Convex to the Origin :
 An indifference curve is convex to the origin because of diminishing MRS.
 MRS declines continuously because of the law of diminishing marginal utility.
 MRS indicates the slope of indifference curve.

2) Indifference Curve Slopes Downwards :

 It implies that as a consumer consumes more of one good, he must consume less of the other
good. It happens because if the consumer decides to have more units of apple, he will have to
reduce the consumption of bananas, so that total satisfaction remains the same.

3) Higher Indifference Curves Represent Higher Levels of Satisfaction :

 Higher indifference curve represents large bundle of goods which means
more utility because of monotonic preference.

4) Indifference Curves can Never Intersect Each Other :

 As two indifference curves cannot represent the same level of satisfaction,
they cannot intersect each other.
 It means only one indifference curve will pass through a given point on an indifference map.
 Indifference Curves IC1 An Indifference Curve Can never
Y
and IC2 can never touch X-axis or Y-axis :
intersect each other
 If the indifference curve touches
Y-axis, it would mean that the
A
consumption of commodities on
the X-axis is zero.
Bananas

C  If the indifference curve touches

X-axis, it would mean that the
B IC2
IC1 consumption of commodities on
the Y-axis is zero.
O Apples
X
So, an Indifference curve can
never touch any of these axes.
Budget Line
 We have discussed different combinations of two goods that
provide same level of satisfaction. But, which combination,
will a consumer actually purchase, depends upon his
income („consumer budget‟) and prices of the two
commodities.
 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 is a 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
combinations is equal to the monetary income of the
consumer.
 Schedule of Budget Line
Suppose, a consumer has a budget of ₹ 20 to be spent on two commodities : Apples (A) and Bananas
(B). If apple is priced at ₹ 4 each and banana at ₹ 2 each, then the consumer can determine the
various combinations (bundles), which form the budget line. The possible options of spending income
of ₹ 20 are given in Table.
Apples Bananas Y Budget Line
Combination Income (Y) = 20
(Rs.4 each) (Rs.2 each) C
10 J
Unattainable
E 5 0 5 × 4 + 0 × 2 = 20 I Combination

Bananas (B)
8
H
F 4 2 4 × 4 + 2 × 2 = 20 6
G
G 3 4 3 × 4 + 4 × 2 = 20 4 D
F
H 2 6 2 × 4 + 6 × 2 = 20 2 Point D indicates that
income is underspent E
I 1 8 1 × 4 + 8 × 2 = 20 X
O 1 2 3 4 5
J 0 10 0 × 4 + 10 × 2 = 20 Apples (A)

Explanation :
 The number of apples are taken on X-axis and bananas on the Y-axis.
 At Point „E‟, the consumer can buy 5 apples by spending his entire income of Rs. 20 only on apples.
 At Point „J‟, the entire income is spent only on bananas.
 By joining other combinations like F, G, H and I, we get a straight line „AB‟ known as Budget Line or Price Line.
 Every point on this budget line indicates those bundles of apples and bananas, which the consumer can purchase by spending
his entire income of ₹ 20 at the given prices of goods.
More about
Budget Line
 Budget line AB slopes downwards.
 Bundles which cost exactly to consumer‟s
money income lie on the budget line.
 Bundles which cost less than the
consumer‟s money income shows under-
spending and lie inside the budget line.
 Bundles which cost more than the
consumer‟s money income are not
available to the consumer and lie outside
the budget line.
 Budget Set  It is the set of all possible combinations of
two goods which a consumer can afford with
his given income and prices in the market.
 It is a quantitative combination of two
goods which can be purchased by a
consumer from his given income.

Equation of a Budget Line

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 a
Budget Line
 Budget line slopes downwards as more of
one good can be bought by decreasing
some units of the other good.
 Slope of Budget Line =
Units of Bananas B willing to sacrifice ∆B
=
Units of Apples A willing to gain ∆A
 Price Ratio indicates the slope of the
Budget Line therefore it is equal to the
„Price Ratio‟ of two goods.
Price of X (Px) Px
 Price Ratio = =
Price of Y (Py) Py
 Properties of Budget Line
Budget Line is Downward Sloping
Budget Line has a
negative slope, i.e. it
slopes downwards as
more of one good can be
bought by decreasing
some units of the other
good.
Budget Line is a Straight Line
Slope of a budget line
is represented by the
price ratio which is
constant throughout,
therefore the budget
line is a straight line.
 Shift in Budget Line

Budget Line can be shifted

only because of two factors :

If the income of a If the price of the

consumer commodity
changes changes
 Case 1. If the income of consumer changes :

Explanation : Y
Effect of Change in
 With the increase in income, the consumer B1 Income on Budget Line

will be able to buy more bundles of goods. It B

Bananas (B)
B2
will shift the budget line to the right from AB
to A1B1.
 Similarly, a decrease in income will lead to a O A2 A A1
X

leftward shift in the budget line to A2B2. Apples (A)

Case 2. If the price of a commodity change :

Change in prices of both 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.
 Change in price of the commodity on the X-axis (Apples) : Y
Change in Price of
Explanation : Apples
 When price of apples falls, then new budget B

Bananas (B)
line is represented by a shift in the budget line
to the right from „AB‟ to „A1B‟.
 Similarly, A rise in the price of apples will shift O A2 A A1
X

the budget line towards left from „AB‟ to „A2B‟. Apples (A)

Change in price of the commodity on the Y-axis (Bananas) : Y

Change in Price of
Explanation : B1
Bananas

Bananas (B)
B
 If the price of banana increases then Budget B2
Line shifts leftward from AB to AB2.
 If the price of bananas decreases then Budget O A
X

Line shifts rightward from AB to AB1. Apples (A)

 Indifference
Curve Analysis
Approach  Consumer‟s 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 taking the Indifference map and
Budget Line together.
 On an indifference map, a higher indifference
curve represents a higher level of satisfaction.
 Therefore, a consumer always tries to remain
at the highest possible indifference curve,
subject to his budget constraint.
Consumer‟s Equilibrium under indifference curve theory must meet
the following two conditions :
𝑃𝑥
Case 1. MRSXY = Ratio of prices or
𝑃𝑦
𝑃𝑥
a) If there are two gods X and Y then the first condition to be fulfilled is MRSXY =
𝑃𝑦
𝑃𝑥
b) If MRSXY > , it means that to obtain one more unit of good X, the consumer is willing to
𝑃𝑦
sacrifice more units of good Y as compared to what is required in the market.
 As consumption increases the satisfaction of good X falls because of the Law of DMU.
𝑃𝑥
 As a result, MRS falls and continues to fall till MRSXY =
𝑃𝑦
𝑃𝑥
c) If MRSXY < , it means that to obtain one more unit of good X, the consumer is willing to sacrifice
𝑃𝑦
less unit of good Y as 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.
 Case 2. MRS Continuously Falls
 The second condition for consumer‟s equilibrium is that MRS must be diminishing at the point of
equilibrium, i.e. the indifference curve must be convex to the origin at the point of equilibrium.
 Thus, both the conditions need to be fulfilled for a consumer to be in equilibrium.
Explanation :
 IC1, IC2 and IC3 are three indifference curves and AB is the
budget line.
 With the constraint of the budget line, the highest indifference Y
Consumer’s Equilibrium by
curve, which a consumer can reach, is IC2. Indifference Curve Approach
 The Budget Line is tangent to the indifference curve IC2 at point B F
E.
 This is the point of consumer equilibrium where the consumer

Commodity Y
H
purchases OM quantity of commodity „X‟ and ON quantity of N
E
IC3
commodity „Y‟.
IC2
 As Budget Line can be tangent to one and only one indifference G
IC1
curve, the consumer maximizes his satisfaction at point E, where X
both the conditions of the Consumer‟s Equilibrium satisfy i.e. O M A
𝑃𝑥 Commodity X
a) MRSXY = Ratio of prices or 𝑃𝑦
b) MRS continuously falls.