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Consumers Equlibrium With IC Analysis

The document discusses consumer equilibrium through indifference curve analysis. It provides two conditions for consumer equilibrium: 1) The marginal rate of substitution (MRS) between two goods must equal the ratio of their prices. If MRS is greater/less than the price ratio, the consumer will buy more/less of the good until MRS equals the price ratio. 2) MRS must continuously fall, meaning the indifference curve must be convex to the origin at the point of equilibrium. The diagram shows a consumer reaching the highest indifference curve possible given their budget constraint, satisfying both conditions of MRS equaling the price ratio and MRS continuously falling.

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AKASH KULSHRESTHA
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3K views3 pages

Consumers Equlibrium With IC Analysis

The document discusses consumer equilibrium through indifference curve analysis. It provides two conditions for consumer equilibrium: 1) The marginal rate of substitution (MRS) between two goods must equal the ratio of their prices. If MRS is greater/less than the price ratio, the consumer will buy more/less of the good until MRS equals the price ratio. 2) MRS must continuously fall, meaning the indifference curve must be convex to the origin at the point of equilibrium. The diagram shows a consumer reaching the highest indifference curve possible given their budget constraint, satisfying both conditions of MRS equaling the price ratio and MRS continuously falling.

Uploaded by

AKASH KULSHRESTHA
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Consumer’s Equilibrium through Indifference Curve Analysis

On an indifference map, higher indifference curve represents a higher level


of satisfaction than any lower indifference curve. So, a consumer always
tries to remain at the highest possible indifference curve, subject to his
budget constraint.

Conditions of Consumer’s Equilibrium:


The consumer’s equilibrium under the indifference curve theory must meet
the following two conditions:

(i) MRSXY = Ratio of prices or PX/PY


Let the two goods be X and Y. The first condition for consumer’s equilibrium
is that

MRSXY = PX/PY
a. If MRSXY > PX/PY, it means that the consumer is willing to pay more for X
than the price prevailing in the market. As a result, the consumer buys
more of X. As a result, MRS falls till it becomes equal to the ratio of prices
and the equilibrium is established.
b. If MRSXY < PX/PY, it means that the consumer is willing to pay less for X
than the price prevailing in the market. It induces the consumer to buys 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.
(ii) 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. Unless MRS continuously
falls, the equilibrium cannot be established.
Thus, both the conditions need to be fulfilled for a consumer to be in
equilibrium.

Let us now understand this with the help of a diagram:

In Fig. 2.12, IC1, IC2 and IC3 are the three indifference curves and AB is the
budget line. With the constraint of budget line, the highest indifference
curve, which a consumer can reach, is IC2. 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.
All other points on the budget line to the left or right of point ‘E’ will lie on
lower indifference curves and thus indicate a lower level of satisfaction. As
budget line can be tangent to one and only one indifference curve,
consumer maximizes his satisfaction at point E, when both the conditions
of consumer’s equilibrium are satisfied:

(i) MRS = Ratio of prices or PX/PY:


At tangency point E, the absolute value of the slope of the indifference
curve (MRS between X and Y) and that of the budget line (price ratio) are
same. Equilibrium cannot be established at any other point as MRSXY >
PX/PY at all points to the left of point E and MRSXY < PX/PY at all points to
the right of point E. So, equilibrium is established at point E, when MRS XY =
PX/PY.
(ii) MRS continuously falls:
The second condition is also satisfied at point E as MRS is diminishing at
point E, i.e. IC2 is convex to the origin at point E.

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