Explain consumers equilibrium with the help of indifference curve approach . Use diagram?
Consumers Equilibrium through Indifference Curve Approach.
According to Indifference Curve approach, consumers equilibrium is determined if the following two conditions are satisfied :
(i) MRSxy = Px/Py
(ii) MRSxy is declining.
MRSxy is the rate at which the consumer is willing to sacrifice Y to obtain one more unit of X.
Thus, we can say that ''A consumer is in equilibrium at a point where budget line is tangent to Indifference Curve".
Slope of Indifference Curve = Slope of budget line i.e.
In the diagram, equilibrium is at point E, where the budget line touches the highest attainable indifference curve IC2 within consumer's budget.
Bundles on the Indifference Curve IC3 are not affordable within budget.
Bundles on the Indifference Curve IC1 (i.e. points F and G) are lying on a lower Indifference Curve i.e. will have lower utility levels as compared to the tangency point E. Therefore, the consumer will choose only the tangency point on the budget line.
Therefore, E is a point of consumer's equilibrium where he maximizes his satisfaction. Point E is also called the"Optimum Consumption Point" where he consumes OX1 of X and OY1 of Y.
If MRSxy > MRE it implies that the consumer is willing to sacrifice more unit of Y than what market requires. This induces the consumer to buy more of X. When he buys more of X, utility derived from X falls and he is willing to sacrifice less of Y. Thus MRSxy starts declining. He continues to consume more of X, till MRSxy=MRE=Px/Py.
If MRSxy < MRE, it implies consumer is willing to sacrifice fewer units of Y than what the market requires. He decreases the consumption of X. Due to this MRSxy began to rise, he continues to decrease the consumption of X till MRSxy = MRE.