Chapter 2

Consumer’s Equilibrium
Who is a consumer
 A consumer is the one who buys goods and
services for satisfaction of wants.

 Main aim – to maximize satisfaction from

spending his income on goods and services
Laws/ principles to attain highest
satisfaction
 Cardinal utility Approach ( Marshall’s Utility
Analysis)

 Ordinal utility Approach ( Indifference curve

Analysis)
Cardinal utility Approach ( Marshall’s Utility Analysis)

 Suppose you have just eaten some ice –

cream and chocolates.

 Can you tell how much you are satisfaction

from these goods?
Meaning of utility
 Refer to want satisfying power of a
commodity.

 Utility differs from person to person , place to

place or time to time.
Measurement of utility
 Cardinal measure of utility is measured in cardinal
( number) terms.
Like 1,2,3

 Suppose you assign 20 utility to ice cream then what to

assign to chocolate ?

 If you like chocolate more – assign more than 20

 If you like chocolate less – assign less than 20
 Suppose we assign chocolate as 10 , then it is
concluded that you like ice cream more than
chocolates.
Concepts of utility
 Utility

Total utility Marginal

(TU) utility (MU)
Total Utility ( TU)
 Total satisfaction obtained from the
consumption of all possible units of a
commodity.
 Eg: suppose we consumer 2 ice – cream
 Utility from 1st ice cream = 20
 Utility from 2nd ice cream = 16

 Total utility from ice- cream = 20+16= 36

 TUn= U1+U2+U3 +…………Un
Marginal Utility ( MU)
 Additional utility derived from the
consumption of one more unit of the given
commodity.
Marginal Utility ( MU)
1st formula - MUn= TUn-TUn-1

2nd formula- MU= Change in total utility/ change in

number of units
∆TU/ ∆Q

Eg: MU (3)= TU(3)- TU(3-1)

Or, MU (3)= TU(3)- TU(2)

MU(3)= 46-36=10
TU and MU
Ice cream consumed Marginal utility ( MU) Total Utility(TU)
1 20 20
2 16 36
3 10 46
4 4 50
5 0 50
6 -6 44
TUn= MU1+MU2+MU3+…………MUn
TU= ∑MU
Law of diminishing marginal utility
( DMU)

 As we consume more and more units of a

commodity, the utility derived from each
successive unit goes on decreasing.

 Applies to all goods and services.

Assumptions of Law of diminishing
marginal utility ( DMU)
 Cardinal measurement of utility – utility can
be measured and expressed in quantitative
terms like 1,2,3
 Consumption of reasonable quantity: glassful

of water / spoon ful of water.

 Continuous consumption: 1 ice – cream in

morning , 1 in evening will not reduce utility.

 No change in quality
 Rational consumer- aims at max satisfaction
Graph of DMU
Ice cream consumed Marginal utility ( MU) Total Utility(TU)
1 20 20
2 16 36
3 10 46
4 4 50
5 0( point of satiety) 50
6 -6 44
Question 1

Units TU MU
0 0 0
1 10 10
2 25 15
3 38 13
4 48 10
5 55 7

Calculate marginal utility

Question 2

Units MU TU
1 9 9
2 6 9+6=15
3 4 9+6+4=19
4 2 21
5 0 21
6 -2 19

Calculate total utility

Question 3
 Calculate missing figures

Units 16 TU MU
1 16 -16
2 - 28 12
3 -36 8
4 -42 6
5 40 - -2
Consumer’s Equilibrium
 Equilibrium means a state of rest or a
position of no change.

 When there are no intensions to change the

level of consumption as max satisfaction has
derived.
 Consumer equilibrium- where the consumer

is having maximum satisfaction with limited

income and no tendency to change his
expenditure.
Conditions of consumer equilibrium
 A rational consumer will aim to balance his
expenditure in such a manner, so that he gets
maximum satisfaction with minimum
expenditure.

2 situations :
 1. consumer spends his entire income on a single
commodity
 2. when consumer spends his entire income on
two commodities.
Consumer equilibrium for a single
commodity
 A consumer purchasing a single commodity
will be at equilibrium , when he is buying
such a quantity of a commodity , which gives
him maximum satisfaction.

 2 factors are important

 1. price of a commodity
 2. expected utility
Equilibrium condition
 Consumer is consuming a single commodity (
say X)
 Consumer Equilibrium=

MUx= PX
Marginal utility (MUx) is equal to price (Px) paid
for the commodity
If MUX=PX
 1. If MUX>PX, he goes on buying because
benefits are more than cost.MU decline due
to law of diminishing marginal utility , when
MU gets equal to price, consumer gets max
satisfaction and is in equilibrium.
 2. If MUX<PX, he will have to reduce

consumption until it become equal to price.

Consumer equilibrium for a single commodity

Units of X Price (Px) Marginal Marginal Difference Condition

utility( MU utility in between s
x) terms of ₹ Mux and
Px
1 10 20 20/1=20 20-10=10 MUX>PX
2 10 16 16/1=16 16-10=6 MUX>PX
3 10 10 10/1=10 10-10=0 Consumer
Equilibriu
m
4 10 4 4/1=4 4-10=-6 MUX<PX
5 10 0 0/1=0 0-10=-10 MUX<PX
6 10 Marginal
-6 utility in-6/1=-6
terms of Money = Marginal
-6-10=- utility /
MUX<PX
marginal utility in one rupee
16
 MUX/ MUm= Px

 MUx/Px= MUm
Consumer equilibrium for Two
commodities
 A consumer gets maximum satisfaction, when
ratios of MU of two commodities and their
respective prices are equal and MU falls as
consumption increases.
 For good X ( Eq 1)
 MUx/Px= MUm

 For good Y ( Eq2)

 MUy/Py= MUm
 Equating Eq 1 and Eq 2
 MUx/Px= MUy/Py
 ORDINAL UTILITY APPROACH ( INDIFFERENCE
CURVE)
ORDINAL UTILITY APPROACH ( INDIFFERENCE CURVE)

 If a consumer 2 goods – apples and bananas

 1. whether he prefer apples over banana
 2. whether he prefer banana over apples
 3. if he is indifferent between apples and

banana- equally preferred both

 Ordinal approach does not assign number to

utility rather rank them like 1st, 2nd, 3rd, …
 If he likes apples more than banana he will

give apple as 1st , banana as 2nd .

 Ordinal approach is the utility expressed in
terms of ranks
Indifference curve
 Graphical representation of various
alternative combinations of bundles of
commodity among which the consumer is
indifferent. ( same satisfaction)
Combinations Apple Bananas
P 1 15
Q 2 10
R 3 6
S 4 3
T 5 1
Monotonic Preferences
 Rational consumer will always prefer more of
a commodity as it will give him higher
satisfaction.

 1 bundle – 10A, 10B

 2 bundle- 9A,7B

 Consumer will prefer 1st bundle over 2

bundle.
Indifference Map
 Family of indifference curve that represent
consumer preference over all the bundles of
two goods.

 Represent all combinations which give them

same satisfaction.
Marginal Rate of Substitution ( MRS)
 Rate at which commodity can be substituted
with each other, so that total satisfaction of
the consumer will same.

 MRS= units of banana willing to sacrifice/

units of apples gain

 MRS= ∆B/ ∆A
MRS between Apple and Banana
Combinations Apple Bananas MRS
P 1 15 -
Q 2 10 5B:1A
R 3 6 4B:1A

S 4 3 3B:1A

T 5 1 2B:1A
Assumptions of IC
1. Two commodities – fixed income spend on
two goods

2. Non Satiety – has not reached to the point

of satisfaction, will prefer more of the
commodity
3. Ordinal utility – consumer can rank his
preferences
4. Diminishing MRS
5. Rational consumer
Properties of IC
1. Always convex to the origin – Due to
diminishing MRS

2. Always slopes downwards- more of one

good will result in less of another good .
 3. higher indifference curve will represent higher
level of satisfaction.

 4. Two indifference curve will never intersect.

 5. indifference curve will never touch X axis or Y

axis - consumption of any one good can’t be zero.
Budget Line
 Budget – real income or purchasing power of
a consumer from which he can buys different
goods and services.

 Budget Line – Graphical representation of all

possible combinations of two goods which
can be purchased with given income and
prices, cost of combinations will be equal to
money income of the consumer.
 Suppose a consumer has ₹20. He wants to
spend it on two commodities X and Y @ ₹
10 .

 1. Buys 2 units of x (2,0)

 2. Buys 2 units of y(0,2)
 3. Buys 1 unit of X and 1 unit of Y (1,1)

 Budget line/ price line –downward sloping

straight line, all these 3 bundles of 2
commodities which a consumer can buy.
 Budget set
 All possible combinations of two goods which
a consumer can afford, given his income and
prices in market.
Combinations Apples @₹4 Bananas @₹2 Money spend

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
Shift in the Budget Line
 Change in budget line either due to :

 1. income of the consumer

 2. prices of the commodity

Income of the consumer
Income Increased – Rightward Shift
Income reduced – Left ward Shift
Prices of the commodity
 1. change in he price of both the
commodities
 2. change in the price of commodity ( X axis)

– Apple

 3. change in the price of commodity ( Y axis)

– Banana
 1. change in he price of both the
commodities
 Fall in the price of both goods – Rightward

shift in the budget line

 Rise in the price of both commodities –

Leftward Shift in budget Line.
 2. change in the price of commodity ( X axis)
– Apple
 When price of apple falls, the new budget line

will shift to the right.

 When price of apple falls, the new budget line

will shift to the left
 3. change in the price of commodity ( Y axis)
– Banana
 When price of banana falls, the new budget

line will shift to the right

 When the price of banana rise , the new

budget line will shift to the left.
Consumer’s equilibrium through IC
analysis
 Consumer equilibrium – the point of
maximum satisfaction is achieved by studying
indifference curve and budget line together.

 Conditions of consumer equilibrium

 1. MRSxy= Px/Py
 2. MRS continuously falls

 Both the conditions have to be fulfilled for a

consumer to be in equilibrium.
Numericals
 Suppose the price of a commodity if 9, MU in
terms of money is given as below , calculate
consumer equilibrium in terms of units

Units MU
1 12
2 10
3 9
4 6
 The price of a commodity is 6, how many
units a consumer to be in equilibrium

Units TU MU
1 10 10
2 18 8
3 25 7
4 31 6
5 34 3
6 34 0
 A consumer income is 200 . He spends it on
purchase of good X and Good Y . Price of X
are 40 and price of Y are 20
 1. write the equation of budget line
 2.Write 2 combinations which lie on budget

line (4,2),(3,4),(2,6),(1,8)
 3. write any 2 combinations which are part of

budget line but do not lie on budget line.

(5,1),(1,1),(4,1)(3,1)(2,1)
 40 X + 20Y = 200

 1:8, 2:6

 1:2,2:2
 Calculate MRS when the consumer is in
equilibrium

 Prices of good X is 4 and price of good y is 2

 A consumer has 250 to spend on good x and
good y with prices 25 and 40 per unit.

 Write the budget line equation for the

consumer
 What is value of slope of budget line(-Px/Py)
 Calculate X and Y intercept. (10,6)
 How many units are consumed if he spends

his entire income on good X

 Price of good X is 10 and price of good Y is
12. A consumer buys 5 units of good X and 4
units of good Y . Calculate income of the
consumer .
 Write the possible bundles if the income of
the consumer is 40 and both the goods are
priced at 10.
 (0,4), (1,3), (2,2), (3,1), (4,0)
 Suppose there are 3 bundles
 (10,10)
 (10,9)
 (7,10)

 Which is preferred by the consumer.

 A consumer is indifferent for ( 4,7) and (4,8)
bundle . Whether consumer has monotonic
preferences or not.