Consumer Equilibrium Notes - Chapter 2, Microeconomics, Class 12 - Commerce PDF Download

Consumer’s Equilibrium

Consumer :: Consumer is an economic agent who consumes goods and services for DIRECT SATISFACTION OF HIS / HER WANTS

Utility :: It refers to want - satisfying power of a commodity .. Thus is refers to satisfaction derived from the consumption of a commodity. Example - A bread has the power to satisfy hunger , books fulfil our desire for knowledge

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Special Points

(1) Utility Is Not Always Usefulness :: The dictionary meaning of utility is given as
usefulness. But in economics both terms are not same . A commodity may not be useful, yet it
may have utility for a particular person. For example, liquor is considered to be harmful for
health, yet it may have a high degree of utility for an alcoholic.
(2) Utility Is Subjective as it varies from person to person , time to time & place to place
(3) Satisfaction Need Not Not Involve Actual Pleasue E.G treatment of broken legs only gives satisfaction to the patient but doesnot provide him any pleasure
(4) Utility can be expressed in two different ways namely :
Cardinal Utility : It is given by Marshal .It states that utility can be measured and compared in numerical terms like 50, 40, 30.Thus the consumer can assign utils to the commodities, like 20 utils to apple and 15 utils to banana
Ordinal Utility :: Given by Hicks and Allen. It states utility cannot be measured in numerical terms but only can be expressed in preference terms. Thus if the consumer likes apple more than banana, then he will give 1st rank to apple and 2nd rank to banana.

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Relationship between Total Utility and Marginal Utility
Consumption of every additional units adds to total utility as we know

TU = MU₁ + MU₂ + MU₃ + ..............+ MU_N

Since MU diminishes in accordance with law of diminishing marginal utility, thus relationship can be explained as

(1) Tu Increases at Diminishing Rate When Mu Is Decreasing but Positive.
The shaded area under TU curve show the positive but diminishing (size of area is decreasing)
marginal utility upto the 5th unit.

(2)Tu Is Maximum When Mu = Zero. It means that consumer doesnot have more desire
for commodity and this situation is known as saturation point ( 6th unit )

(3) Tu Declines When Mu Gets Negative( 7th unit)

Law of Diminishing Marginal Utility

This law states as the consumer has more and more standard units of a commodity are continuously consumed, marginal utility derived from every additional unit must decline. This law also states that after a certain level MU can be negative due to unpleasant experience or dissatisfaction.

For Example  on a hot summer day, when a person is very thirsty, he gets maximum satisfaction when he drinks the first glass of water as his intensity of thirst is at its highest. The second glass of water will give him less utility as intensity of thirst is reduced. The utility from third glass will still be less.After he gets fully satiated , any further consumption may cause disutility.

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Marshall “ The additional benefit a person derives from a given increase of his stock
 of a thing diminishes with every increase in the stock that he already has “

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This law was first given by German Economist H.H. GOSSEN , therefore it was also known as ‘GOSSEN’S FIRST LAW.’
 Prof. Boulding calls it “ Law of Eventually Diminishig MU ”

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Basic Assumptions

(1) Commodity is consumed in some STANDARD UNITS such as a cup of tea, a glass of water and NOT A SPOON OF TEA OR WATER
(2) There is a CONTINUOUS CONSUMPTION of the commodity as second glass of water after two hour may give less , equal or more utility
(3) QUALITY OF COMMODITY SHOULD NOT CHANGE as a refrigerated cold second glass of water will give more utility .IN OTHER WORDS GOODS CONSUMED SHOULD BE HOMOGENEOUS (similar units)
(4) Consumer must behave in a RATIONAL MANNER 

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SPECIAL POINTS
 (1) MU MAY INCREASE INITIALLY like in case of Money , Good books.
(2) Law of DMU says nothing about the rate of decline of MU . It does not specify whether
MU falls at a slow rate or a fast rate or constant rate

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Consumer Equilibrium

MEANING :: Consumer’s equilibrium refers to a situation where in a consumer gets MAXIMUM SATISFACTION OUT OF HIS GIVEN INCOME and he has no tendency to make any change in his existing expenditure.
In other words a consumer is in equilibrium when , given his income and market prices, he plans his expenditure ( on different goods and services ) in such a manner that he maximises his total satisfaction

One Commodity Case

CONDITION :: Consumer equilibrium in case of single commodity is attained when Marginal Utility in terms of price of the commodity is equal to its Marginal utility of Money

Assuming Marginal worth of money to be one util ( 1 Rs = 1 util ) , the equation changes to

{ consumer is ready to pay exactly equal to utility derived }

Suppose the commodity is sold for Rs 30 and the marginal utility of one rupee is one util

In case LESS THAN EQUILIBRIUM QUANTITY IS CONSUMED { LET SAY 2 UNITS OF “X” } , then it would be situation of MU_x > P_x or MU_x / P_x > MU_M which indicates utility derived is greater than what consumer is ready to pay and hence SITUATION OF CONSUMER SURPLUS arises. THUS CONSUMER WILL INCREASE HIS CONSUMPTION As the consumer will buy more of X good , his additional utility ( MUx ) will Decrease due to operation of law of DMU . This process will continue until consumer gets into equilibrium
situation that is 

In case MORE THAN EQUILIBRIUM QUANTITY IS CONSUMED { LET SAY 4 UNITS
 OF “X” } - MU_x / P_x < MU_M which indicates utility derived is less than what consumer is ready
to pay and hence situation of CONSUMER DEFICIT ARISES . Thus consumer will DECREASE
 HIS CONSUMPTION

As the consumer will buy less of X good , his additional utility ( MUx ) will increase due to operation of law of DMU . This process will continue until consumer gets into equilibrium situation that is 

Assumption

(1) It is assumed that the CONSUMER IS RATIONAL that is he aims at maximising the utility
from his purchases
(2) Utility can be measured in CARDINAL NUMBERS like 1, 2,3 and 4 . Thus it is Based on Cardinal utility approach
(3) Marginal Utility of Money is constant
(4) The Law of diminishing marginal utility operates
(5) Consumer’s income is given and remains constant
(6) INDEPENDENT UTILITY which means utility of commodity is not affected by consumption of other goods.

Consumer Equilibrium - Two Case Commodities

“ Consumer will maximise Total Utility when he allocates his money income among various commodities in such a way that the MU of last rupee spent on each commodity is equal”
In this case consumer buy two commodities - ‘X’ and ‘Y’ with his given money income.
In case of one commodity say “Good X” , a Consumer strike equilibrium when

 Similarly for “Good Y “, a consumer will strike equilibrium when 

Thus for any set of two goods , a consumer strikes his equilibrium when he shall DISTRIBUTE
OR ALLOCATE HIS MONEY INCOME between Good “X” and Good “Y” such that the RATIOS
OF MARGINAL UTILITIES FROM GOODS IS EQUAL TO RATIO OF PRICE OF GOODS.
Therefore this law is also known as LAW OF EQUI - MARGINAL UTILITY
This law is also known as “ GOSSEN’S SECOND LAW OF MAX. SATISFACTION ’
Lets understand the concept with the help of numerical example ::
Given :: PX = Rs 3 and PY = Rs 3 and Income of the consumer :: Rs 21
Units Of X MUX MUY

Consumer equilibrium or level of maximum satisfaction is achieved at 3 units of X good and
4 units of Y good . Total expenditure at this level would be would be
= 3 * 3 + 4 * 3 = Rs 21

NUMERICAL QUESTIONS
(Q1) Suppose the price of a commodity is given as Rs.8 and the marginal utility schedule in
terms of money for 4 units is given as :

How many units of the commodity is purchased by the consumer so that his TU is maximum ?

(Q2) The following schedule gives the number of bananas consumed and the total utility derived
of each level of consumption by a consumer. Given that the price of bananas is fixed at Rs. 2 per
banana, determine the optimal level of consumption :

(Q3) A consumer has Rs.24 with him which he wants to spend it on two goods X and Y. The price
of each unit of X and Y is Rs.2 is Rs.3. Marginal utility schedule of X and Y is given as ;

How many units of X and Y goods are purchased by the consumer so that his utility is maximum
?

(Q4) A consumer has Rs.5 with him which he wants to spend on two goods X and Y. The price
of each unit of X and Y is Re.1. Marginal utility schedule of X and Y is given as:

How many units of X and Y commodities are purchased by the consumer so that his TU is
maximum ?

(Q5) Satish has Rs 88 with him . He intended to purchase good X and Y with his money income.
The market price of X and Y is Rs 8.Find out Consumer equlibrium .

(Q6) P_X = Rs 5 and P_Y = Rs 8 and Income of the consumer = Rs 102 and MU_M = 10