2A CONSUMER EQUILIBRIUM

There are two approaches –

i) Cardinal approaches – Utility analysis
ii) Ordinal approaches – Indifference curve analysis

Utility approach
Under utility approach there are two cases
a) Single good
b) Two goods

BASIC CONCEPTS

Q. Define Equilibrium.
Ans. It is a state of rest where there is no tendency to change.

Q. Define utility.
Ans. It is the satisfaction derived from consumption of a good.

Q. Define total utility.

Ans. It is defined as total satisfaction a consumer obtains by consuming a given amount of a particular good. Also,
it is the sum total of marginal utilities.
TU = EMU
Marginal Utility
It is the additional utility derived from consumption of and additional unit of a food.
Or
It is addition to the total utility when one more unit of a good is consumed.
MU = TUn – TUn-1

SCHEDULE AND DIAGRAM OF TU & MU

Units Consumed Total Utility Marginal Utility
0 0 0
1 4 4
2 7 3
3 9 2
4 10 1
5 10 0
6 9 1
DIAGRAM: - M
10
TU
8
Total Utility
6

0 1 2 3 4 5 6 7
Units consumed

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 10

8
Marginal Utility
6

0 1 2 3 4 5 6 7
Units consumed
EXPLANATION
 TU curve is initially upward sloping. This is up to point M. This is because TU is increasing. After point M
TU curve is downward sloping because TU starts falling. Thus, at point, M 1 TU is max.
 MU curve is downward sloping throughout because of law of diminishing marginal utility. MU initially falls,
reaches O and then becomes negative.

RELATIONSHIP B/W TU AND MU

 Make the schedule a diagram
i) TU curve slopes upwards, MU is positive
ii) TU is maximum, MU is O
iii) TU slope downwards, MU is negative.

Q. State and explain the laws of diminishing marginal utility with the help of a schedule and diagram.
Ans. Statement of the law
As we consume more and more units of a commodity, the utility derived from each successive unit goes on
decreasing.
SCHEDULE
Units Consumed MU
1 20
2 16
3 10
4 4
5 0
6 -6

DIAGRAM: - 20

18

16

14

12
MU 10

0 1 2 3 4 5 6 7 8 9 10
Units consumed MU

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 EXPLANATIONS

 In the diagram, MU from each successive unit of ice cream is represented by the points A, B, C, D, E, F. MU
goes on falling from 20 to 16 then 10 and 4. The fifth ice-cream has no utility 50 MU is 0 and after that
additional satisfaction becomes negative.

CONSUMER EQUILIBRIUM UTILITY APPROACH

a) Single goods
b) Two goods

II) CONSUMER EQUILIBRIUM – Indifference curve analysis

Consumer equilibrium – Utility approach
a) SINGLE GOOD
Utility approach
Consumer is in equilibrium when given his income and market price, he plans his expenditure in such a
manner that he maximizes his total satisfaction.

CONDITIONS
 A consumer obtains equilibrium when MU of a good in terms of money in equal to the price of the good.
MUm = Px
𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑢𝑡𝑖𝑙𝑖𝑡𝑦 𝑜𝑓 𝑎 𝑝𝑟𝑜𝑑𝑢𝑐𝑡 (𝑀𝑈𝑥 )
MUm = 𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑢𝑖𝑡𝑙𝑖𝑡𝑦 𝑜𝑓 𝑎 𝑟𝑢𝑝𝑒𝑒 (𝑀𝑈𝑟 )

 Total gain falls as more is purchased after equilibrium

ILLUSTRATION
MU schedule of a consumer is given below

Consumption TU (Rs.) MU (Rs.) Price (Rs.) MP (Rs.) Expenditure Total gain

Willing to pay Market Price (TU – Expendit)
(Unit) (Rs.)
(Rs.)
0 0 0 0 0 0 0
1 15 15 15 10 10 5
2 28 13 13 10 20 8
3 38 10 10 10 30 8
4 44 6 6 10 40 4

EXPLANATION
i) Suppose the price of commodity X in the market is Rs. 10 per unit.
 Utility obtained from 1st unit = 15
Price = Rs. 10
Since, utility is greater than price, consumer will buy this unit.
 Utility obtained from 2nd unit = 13
Price = Rs. 10 / unit
Since, utility is greater than price, consumer will buy this
 Utility obtained from 3 rd unit = 10
Price = Rs. 10 / unit
Since, utility = price, consumer will buy this
 Utility from 4th unit = 6
Price = Rs. 10 / unit
Here, utility is less than price, so consumer will not buy this.

Thus, consumer will buy three units to reach consumer equilibrium.

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ii) Utility in case of 1st commodity = 15
Price = 10
Gain = 15 – 10 = Rs. 5 (therefore, utility – price = Gain from that unit)

Similarly, gain from 2 nd unit i.e. 13 – 10 = Rs. 3

Gain from 3rd unit is 10 – 10 = Rs. 0

Total gain from 3 units = Rs. 8 (5 + 3 + 0)

If he buys fourth unit, gain will be negative i.e. Rs. 6 – 10 = Rs. (- 4)
Now total gain will be less ( 5 + 3 0 – 4) = Rs. 4

CONCLUSION
In a single commodity case, a consumer makes purchase only upto the point where utility of the last unit is
equal to the price of that unit i.e. MU = price

b) CONSUMER EQUILIBRIUM – TWO GOOD (Utility approach)

 Consumer is in equilibrium when given his income and market price, he plans his expenditure in such a
manner that he maximizes his good satisfaction.

CONDITIONS
a) Marginal Utility (MU) of last rupee spent on each good is same.
Law of Equi-Marginal Utility
b) Marginal Utility of the good falls as more of it is consumed (CDMU)

EXPLANATION

a) LAW OF EQUI-MARGINAL UTILITY

Suppose a consumer buys commodities X and Y with his given income.
Incase, of any one commodity X consumer attains equilibrium when
𝑀𝑈𝑥
= 𝑀𝑈𝑚 ------------------- (1)
𝑃𝑥
Where MUm = Marginal utility of last rupee spent on each good. Similarly for commodity Y, consumer will
attain equilibrium When
𝑀𝑈𝑦
= 𝑀𝑈𝑚 --------------------- (2)
𝑃𝑦
Relating eq. (1) & (2) , we can state the equilibrium as follows:
𝑀𝑈𝑥 𝑀𝑈𝑦
= = 𝑀𝑈𝑚
𝑃𝑥 𝑃𝑦
The equilibrium eq. can also be written as
𝑀𝑈𝑥 𝑃𝑥
=
𝑀𝑈𝑦 𝑃𝑦
 If equilibrium condition is not satisfied
𝑀𝑈𝑥 𝑀𝑈𝑦
Suppose >
𝑃𝑥 𝑃𝑦
This means that MU of last rupee spent on X is greater than MU of last rupee spent on Y. As a result
will transfer his expenditure from commodity X to Y. As a result consumption of X rise while y falls.
As a result, MUx falls and MUy rises.
𝑀𝑈𝑥 𝑀𝑈𝑦
This act of transfer of expenditure will continue till =
𝑃𝑥 𝑃𝑦
When they are equal consumer has no reason to further reallocate on the two goods he consumer.

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b) LAW OF DIMINISHING MARGINAL UTILITY
It is a necessary condition because if this law is not operating the equilibrium condition cannot be
reached.
EXPLANATION: -
Suppose as consumption increases, MU remains unchanged i.e. law of diminishing marginal utility
does not operate. Then, is
𝑀𝑈𝑥 𝑀𝑈𝑦
>
𝑃𝑥 𝑃𝑦
Consumer will keep on transferring expenditure from Y ot X till expenditure on Y equals to zero and entire
income will spent on good X.
It means consumer only one good which is unrealistic. Therefore, law of diminishing Marginal Utility is
necessary.

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