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Chapter – 2
Consumer equilibrium
Part A : Cardinal Utility approach
This chapter is discussed under two parts:
Part A : Cardinal Utility approach
Part B : Ordinal Utility or Indifference curve approach
Utility refer to satisfaction received from consuming good or service.
It can be measured with star rating or cardinal number like 1,2,3,4 etc.
Example : 7 Star Hotel or 5 Star Hotel
Cardinal & Ordinal concept of utility
Cardinal concept : Comparision of utility in terms of units like 2,4,6 etc.. is cardinal concept of
utility .
Ordinal concept : Comparision of utility in terms of higher or lower level of satisfaction is ordinal
concept of utility .
Total utility & Marginal utility
Total utility : It is total satisfaction(utility) received from consumption of all unit of commodity .
Marginal utility : It is additional satisfaction(utility) received from consumption of one more
additional unit of commodity .
MUnth = TUn – TUn-1
Relation between Total utility & Marginal utility
Quantity(Units)
0
1
2
3
4
5
6
Schedule of TU & MU
Total utility
Marginal utility
0
20
20-0 = 20
36
36-20 = 16
46
46-36 = 10
50
50-46 = 4
50
50-50 = 0
44
44-50 = -6
44
Relation between TU & MU
a) TU = ∑MU ( TU = Sum total of MU )
TU of a commodity at particular consumption point must be equal to sum total of MU of that
consumption point .
b) TU increases as long as MU is positive
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TU increase with increase in consumption as long as MU is positive .
c) When MU is zero, TU is maximum
TU stop rising at this point . This is known as point of satiety .
d) When MU is negative, TU starts diminishing
When consumption is increased beyond point of satiety , TU start falling as MU is –ve.
e) Decreasing MU implies that TU is increasing at diminishing(decreasing) rate
This shows that MU is the rate of TU .
Law of diminishing marginal utility
This law states that MU tends to decline as consumption of commodity increase.
Example : When a cup of tea is consumed frequently , then MU tends to decline.
Assumption:
a) Consumption of commodity must be continuous.
b) Standard unit of commodity must be consumed like cup of tea , not spoon of tea
Consumer equilibrium
It is situation of maximum satisfaction of consumer by spending his income on different goods
& service.
Consumer equilibrium
Consumer equilibrium refer to maximum satisfaction received by the consumer by spending his
income on different goods & service & attain the point of equilibrium.
Under this concept , we have to determine how much quantity of commodity a consumer should
buy for maximum satisfaction & to attain the point of equilibrium(rest).
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This is discussed with reference to two different situation :
a) When only one commodity is consumed
b) When two or more commodity are consumed
Consumer equilibrium : One commodity case
Suppose the consumer is purchasing goods worth Rs. 3 per unit.. We are given the marginal
utility schedule of the consumer.
Quantity
1
2
3
4
Price
3
3
3
3
MU(Rupees)
8
6
4
3
MUx(Utils)
24
18
12
9
5
3
0.5
1.5
Remarks
MUX > PX , Consumer will
increase consumption
Consumer equilibrium
(MUX = PX)
MUX < PX , Consumer will
increase consumption
Consumer will be at equilibrium when following condition are satisfied:
Condition 1 :
MU(Rupees) = Price
OR
MUM =
(Where, MU(Rupees) =
)
MUM = Price (Rupee worth of satisfaction that consumer expect to get from consumption)
Condition 2 : MU fall as consumption increase due to Law of DMU
Conclusion : At 4 unit of consumption , consumer attains the equilibrium stage .
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Consumer equilibrium : Two commodity case
Suppose the consumer having Rs 88 with him is purchasing two goods X & Y worth Rs. 8 each.
We are given the marginal utility schedule of the consumer.
Quantity
MUx(Utils)
MUy(Utils)
1
88
40
2
72
36
3
64
24
4
56
20
5
48
16
6
40
12
7
32
8
8
24
4
9
16
0
10
8
0
Consumer will be at equilibrium when following two condition are satisfied :
Condition 1 : The ratio of Marginal utility to price should be same in case of both the goods.
This can be derived using following approach
a) A consumer in case of single commodity (say X) will attain equilibrium when
= MUM
b) A consumer in case of single commodity (say Y) will attain equilibrium when
= MUM
Equating a & b , we get
=
= MUM
As MUM assumed to be constant . the above equilibrium condition can be shown as :
=
MUM = Price (Rupee worth of satisfaction that consumer expect to get which is same for both
the good)
When MUx ≠ MUy , then either MUx > MUy or MUx < MUy
When MUx > MUy , it encourage consumer to buy more of X & less of Y. Buying more of X
reduces MUx. Consumer buy more of X till
=
.
When MUx < MUy , it encourage consumer to buy more of Y & less of X. Buying more of Y
reduces MUY. Consumer buy more of Y till
=
.
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Condition 2 : MU falls as consumption increases .
MU of consumption must fall as more of commodity are consumed due to Law of DMU
Additional condition : Consumer must spent his entire income on purchase of both the good
Conclusion : At 8 unit of X & 3 unit of Y consumption , consumer attains the equilibrium stage
X(8×8) + Y(3×8) = X (64) + Y (24) = 88.
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