Micro Economics
CONSUMER EQUILIBRIUM
When a consumer allocates his income to purchase various goods and services in such a way
that maximizes their satisfaction or utility, he is considered to be in equilibrium. This means the
consumer found the best possible use of his income ensuring the highest level of satisfaction.
There are two main approaches to study consumer’s equilibrium. They are as follows:
1. Cardinal utility approach (or Marshall’s utility analysis)
2. Ordinal utility approach (or indifference curve analysis)
CARDINAL UTILITY APPROACH (OR MARSHALL’S UTILITY ANALYSIS)
UTILITY
Utility is defined as the power of a commodity to satisfy a human want. Utility of a commodity
is the total amount of psychological satisfaction that a person gets from consumption of a good
or service. Example : A thirsty person derives satisfaction from drinking a glass of water. So a
glass of water has got utility for the thirsty person.
MARGINAL UTILITY
Marginal utility represents the additional satisfaction or utility a person derives from consuming
one more unit of a particular commodity (good or service).
TOTAL UTILITY:
Total utility is the total satisfaction obtained from the consumption of all possible units of a
commodity.
RELATIONSHIP BETWEEN TOTAL UTILITY AND MARGINAL UTILITY
The relationship between total utility and marginal utility is explained with the help of following
table
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1. When marginal utility decreases but remains positive , total utility increases at a decreasing
rate.
2. When marginal utility is zero , total utility is maximum .
3. When marginal utility becomes negative , total utility starts falling.
THE LAW OF DIMINISHING MARGINAL UTILITY
The Law of Diminishing Marginal Utility is a fundamental concept in economics that states: The
law of diminishing marginal utility states that as a person consumes more of a specific
commodity, such as oranges, the additional satisfaction or utility gained from each additional
unit decreases. In simpler terms, the first orange brings the most satisfaction, but as we eat
more, each additional orange provides less and less satisfaction or utility.. This principle helps
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explain why people make choices about how much of a particular commodity to consume. They
aim to maximize their overall satisfaction by balancing the diminishing satisfaction they get
from each extra unit with the prices of the goods and services available to them.
In practice, this law guides consumer behavior and resource allocation in the economy.
Consumers continue to buy a commodity till the additional satisfaction (marginal utility) they
receive from the last unit equals the price they pay for it.
Assumption of Law of Diminishing Marginal Utility
1. It is assumed that utility can be measured and a consumer can express his satisfaction in
quantitative terms like 1, 2, 3 etc. Unit of measurement of utility is assumed to be ‘util’.
2. Quality of the commodity should not undergo any change. Take the above example of
orange. From the quality point of view a consumer who eats oranges must continue with the
same. He or she cannot change its quality . As change of quality changes the satisfaction level.
3. Consumption should not proceed at intervals. It should be a continuous process. Continuing
with the above example, second unit or orange, if consumed two hours after the first unit
consumed, may give more, less or equal satisfaction.
4. The price of the substitute and complementary goods should not change. If these prices
change, it may be difficult to predict about the utility derived from the commodity.
CONSUMER’S EQUILIBRIUM IN CASE OF A SINGLE COMMODITY
Consumer’s equilibrium in case of a single commodity can be explained on the basis of the law
of diminishing marginal utility. How does a consumer decide as to how much to buy of a
good ,it depends upon two factors.
(a) The price she pays for each unit which is given
(b) The utility she gets
At the time of purchasing a unit of a commodity, a consumer compares the price of the given
commodity with its utility. The consumer will be at equilibrium when marginal utility (in terms
of money) equals the price paid for the commodity say ‘X’ i.e. MUx = PX.
If MUX > Px, the consumer goes on buying the commodity because she is paying less for each
additional amount of satisfaction. As she buys more, MU falls due to operation of law of
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diminishing marginal utility. When MU becomes equal to price, consumer gets maximum
satisfaction and now she is at equilibrium.
When MUX < Px, the consumer will have to reduce consumption of the commodity to raise his
total satisfaction till MU becomes equal to price. This is because she is paying more than the
additional amount of satisfaction that she is getting.
Consumer’s equilibrium (in case of single commodity) can be explained with the help of
following table. Suppose, the consumer wants to buy a good which is priced at `.10 per unit.
Assumed that 1 util = Re. 1.
Consumer’s Equilibrium (in case of a single commodity)
CONSUMER’S EQUILIBRIUM IN CASE OF TWO OR MORE COMMODITIES
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. According to the law of
equimarginal utility a consumer will be in equilibrium when the ratio of marginal utility of a
commodity to its price equals the ratio of marginal utility of other commodity to its price.
Let a consumer buys two goods X and Y. Then equilibrium will be at :
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Thus, at equilibrium , Marginal utility of the last rupee of expenditure on each good is the same.
Let us explain the consumer’s equilibrium in case of two goods with an example. Suppose a
consumer has Rs. 24 with him to spend on two goods X and Y. Further, suppose price of each
unit of X is Rs. 2 and that of Y is Rs. 3
Consumer’s Equilibrium (in case of two goods)
For obtaining maximum satisfaction from spending his income of ` 24, the consumer will buy 6
units of X by spending ` 12 (` 12 = 2 × 6) and 4 units of Y by spending ` 12 (` 12 = 2 × 6). This
combination of goods brings him maximum satisfaction (or state of equilibrium) because a
rupee worth of MU in case of good X is 5 (MUx/Px = 10/2) and in case of good Y is also 5.
(MUY/PY = 15/3) (= MU of last rupee spent on each good)
Suppose, MUx/Px is greater than MUy/Py. This means that MU from last rupee spent on X is
greater than the MU of the last rupee spent on Y. This induces the consumer to transfer his
expenditure from Y to X. As a consequence, MUx falls and MU rises. The act of transfer of
expenditure continues until MUx/Px becomes equal to MUy/Py.
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