Chapter 2 Consumer's Equilibrium
- Utility: It is the power or capacity of a commodity to satisfy human wants. It is measured in terms of utils.
- Marginal utility (MU): It is the additional satisfaction derived by consuming an additional unit of a commodity.
- Total Utility(TU): It is the sum of all marginal utilities derived by consuming all the units of a commodity.
Law of diminishing marginal utility
It states that as we go on consuming more and more units of a particular commodity, the MU derived from each successive unit goes on falling.
- Relationship between TU and MU:
Schedule:
Diagram :
(1). When TU rises at diminishing rate, MU falls but positive.
(2). When TU is maximum, MU is zero.
(3). When TU is falling, MU becomes negative.
Consumer Equilibrium
Law of diminishing marginal utility
It states that as we go on consuming more and more units of a particular commodity, the MU derived from each successive unit goes on falling.
Schedule:
Diagram :
Meaning: It refers to the situation in which a consumer spends his given income on purchasing a commodity and gains maximum satisfaction having no urge to change that commodity.
Cardinal Approach
1. Single Commodity Case
-
In this case consumer is consuming only one good/ commodity.
-
The condition to be fulfilled for the attainment of consumer equilibrium is:
MU of product in terms of money = Price of the product
i.e MU of product / MU of rupee = Price of the product
Here MU of rupee is defined as the extra utility when an additional rupee is spent on a good.
In the above example the consumer consumes 5 units of apple and price of an apple to be rupee 2 per unit and with each successive units his MU falls.
Here we have assumed that MU of a rupee to be 2 units and price of an apple is to be rupees 2 per unit.
-
the consumer attains equilibrium where his MU in terms of money (2 utils) is equal to the price (2)
*by consuming 3 units of apple he is at equilibrium.
2. Double Commodity Case
-
In this case the consumer consumes two commodities. the condition for equilibrium is:
MUx = MUy = MUm
Px Py
OR
MUx = Px = MUm
MUy Py
-
In this case price of both the goods are same.
MUx = MUy = MUm
Px Py
Now if Px and Py are equal this means
Px = 1
Py
Assuming, MUm = 1. now the consumer would be at equilibrium when within his income his
MUx =1
MUy
Assumption is that the consumer has only rupees 5. here if the consumer spends all his rupees 5 on A then he gets 33 utils whereas if he consume all B he gets 28 utils, but in this manner he would be consuming one good.
But if he spent rupee 1 on A and rupee 2 on B and so on then by spending the 4th and 5th rupee his MU is same from A and B.
MUx = PX = MUm
MUy Py
7 = 1 = 1
7 1
- by consuming in such a manner he gets maximum utils
Indifference Curve
Meaning: It is a curve shows all the possible combination of two goods that gives same level of satisfaction to the consumer.
Schedule:
MRS = 🛆Y / 🛆X
Assumption of indifference curve:
(1). consumer behaves rationally i.e he always tries to maximize his satisfaction.
(2). the consumer can rank his preferences on the basis of satisfaction.
(3). price of goods and income of consumer are given.
(4). consumer preferences are monotonic that is one bundle is better than other in terms of maximize satisfaction.
#Monotonic Preference:It means that a rational consumer always prefer more of a commodity as it offers him a higher level of satisfaction.
Properties of Indifference Cure :
(1). Indifference curve are always convex to the origin: An indifference curve is convex to the origin because of diminishing MRS. MRS declines continuously because of the law of diminishing marginal utility. it must be noted that MRS indicates the slope of indifference curve.
(2). Indifference curve slope downwards: It implies that as a consumer more of one goods, he must consume less of the other goods. it happens because if the consumer decides to have more units of one good, he will have to reduce the number of units of another goods, so that utility remains same.
(3). Higher IC represents higher levels of satisfaction : Higher IC represents large bundles of goods which means more utility because of monotonic preferences.
(4). Indifference curve never intersect each other: As two indifference curves cannot represent the same level of satisfaction, they cannot intersect each other. it means, only one indifference curve will pass through a given points on an indifference map.
(5). Indifference curve can never touch both X or Y axis, as it shows combination of two goods, not one good.
can't be possible as consumer consumes two goods at a time.
-
Indifference map: It is a collection of IC's reflecting different level of satisfaction.
-
Budget line: It is the graphical presentation of all the bundles which a consumer can consume with his income that is given and at prevailing market prices.
- properties of budget line:
(a). budget line is downward slopping because the consumer can buy more of one good by loosing the other as the income or budget is constant.
(b). budget lines changes its position only if prices of either of the goods changes or budget increases or decreases.
-
Budget set: Set of all the bundles that the consumer can buy with his income at prevailing market places.
-
Difference between Budget line and Budget set:
(1) Budget set: (meaning mentioned above)
Budget line: (meaning mentioned above)
(2) Budget set: The bundles of budget set lie either on or below the budget line.
Budget line: The bundles of budget lines lie only on the budget line.
- In this case consumer is consuming only one good/ commodity.
- The condition to be fulfilled for the attainment of consumer equilibrium is:
MU of product in terms of money = Price of the product
i.e MU of product / MU of rupee = Price of the product
Here MU of rupee is defined as the extra utility when an additional rupee is spent on a good.
In the above example the consumer consumes 5 units of apple and price of an apple to be rupee 2 per unit and with each successive units his MU falls.
Here we have assumed that MU of a rupee to be 2 units and price of an apple is to be rupees 2 per unit. - the consumer attains equilibrium where his MU in terms of money (2 utils) is equal to the price (2)
*by consuming 3 units of apple he is at equilibrium.
2. Double Commodity Case
- In this case the consumer consumes two commodities. the condition for equilibrium is:
MUx = MUy = MUm
Px Py
OR
MUx = Px = MUm
MUy Py - In this case price of both the goods are same.
MUx = MUy = MUm
Px Py
Now if Px and Py are equal this means
Px = 1
Py
Assuming, MUm = 1. now the consumer would be at equilibrium when within his income his
MUx =1
MUy
Assumption is that the consumer has only rupees 5. here if the consumer spends all his rupees 5 on A then he gets 33 utils whereas if he consume all B he gets 28 utils, but in this manner he would be consuming one good.
But if he spent rupee 1 on A and rupee 2 on B and so on then by spending the 4th and 5th rupee his MU is same from A and B.
MUx = PX = MUm
MUy Py
7 = 1 = 1
7 1 - by consuming in such a manner he gets maximum utils
Indifference Curve
Meaning: It is a curve shows all the possible combination of two goods that gives same level of satisfaction to the consumer.
Schedule:
MRS = 🛆Y / 🛆X
Assumption of indifference curve:
(1). consumer behaves rationally i.e he always tries to maximize his satisfaction.
(2). the consumer can rank his preferences on the basis of satisfaction.
(3). price of goods and income of consumer are given.
(4). consumer preferences are monotonic that is one bundle is better than other in terms of maximize satisfaction.
#Monotonic Preference:It means that a rational consumer always prefer more of a commodity as it offers him a higher level of satisfaction.
Properties of Indifference Cure :
(1). Indifference curve are always convex to the origin: An indifference curve is convex to the origin because of diminishing MRS. MRS declines continuously because of the law of diminishing marginal utility. it must be noted that MRS indicates the slope of indifference curve.
(2). Indifference curve slope downwards: It implies that as a consumer more of one goods, he must consume less of the other goods. it happens because if the consumer decides to have more units of one good, he will have to reduce the number of units of another goods, so that utility remains same.
(3). Higher IC represents higher levels of satisfaction : Higher IC represents large bundles of goods which means more utility because of monotonic preferences.
(4). Indifference curve never intersect each other: As two indifference curves cannot represent the same level of satisfaction, they cannot intersect each other. it means, only one indifference curve will pass through a given points on an indifference map.
(5). Indifference curve can never touch both X or Y axis, as it shows combination of two goods, not one good.
can't be possible as consumer consumes two goods at a time. - Indifference map: It is a collection of IC's reflecting different level of satisfaction.
- Budget line: It is the graphical presentation of all the bundles which a consumer can consume with his income that is given and at prevailing market prices.
- properties of budget line:
(a). budget line is downward slopping because the consumer can buy more of one good by loosing the other as the income or budget is constant.
(b). budget lines changes its position only if prices of either of the goods changes or budget increases or decreases. - Budget set: Set of all the bundles that the consumer can buy with his income at prevailing market places.
- Difference between Budget line and Budget set:
(1) Budget set: (meaning mentioned above)
Budget line: (meaning mentioned above)
(2) Budget set: The bundles of budget set lie either on or below the budget line.
Budget line: The bundles of budget lines lie only on the budget line.
Ordinal Approach
(a). Indifference Curve Approach
- consumer attains equilibrium at the point where budget line is tangent to indifference curve.
MRSxy = Px
Py
OR
MRSxy = MRE
slope of indifference cure = slope of budget line
In the above diagram PT represent budget line and IC1, IC2, IC3 represent different set of satisfactions where IC3 > IC2. Here IC3 is the highest satisfaction but not within the budget of the consumer.Where as IC1 and IC2 are within the budget IC2 > IC1. also budget lines makes a tangent.
consumer attains equilibrium at the point where budget line is tangent to the indifference curve and IC should be convex to the origin i.e MRS should be diminishing at a point of equilibrium.
- Most Important questions
Q1. What is law of diminishing marginal utility?
Q2. What is the Relationship between TU and MU?
Q3. Explain single commodity approach?
Q4. Explain double commodity approach?
Q5. what happens when MUx > MUy
Px Py
Q6. what are the properties of indifference curve?
Q7. Explain the indifference curve approach?
*****(if you face any doubt then comment below)*****
MRSxy = Px
Py
OR
MRSxy = MRE
slope of indifference cure = slope of budget line
consumer attains equilibrium at the point where budget line is tangent to the indifference curve and IC should be convex to the origin i.e MRS should be diminishing at a point of equilibrium.
Q1. What is law of diminishing marginal utility?
Q2. What is the Relationship between TU and MU?
Q3. Explain single commodity approach?
Q4. Explain double commodity approach?
Q5. what happens when MUx > MUy
Px Py
Q6. what are the properties of indifference curve?
Q7. Explain the indifference curve approach?
*****(if you face any doubt then comment below)*****
Thanku mam for notes
ReplyDelete