DHRUV SIRS ECONOMICS CLASSES (9719515194)

CONSUMER EQUILIBRIUM AND DEMAND (18marks) Consumer: one who u!s "oo#s an# ser$%&es 'or sa(%s'a&(%on o' wan(s) The two main approaches to study consumers behaviour are: S.No. Car#%na* U(%*%(! Or#%na* U(%*%(! 1 Given by Prof. Alfred arshall Given by Prof. !.". #ic$s % &tility can be measured 't cannot be measured numerically numerically ( &nit of measurement is )utils Possible for a consumer to scale his preferences. &tility: &tility is the want satisfyin* power of a commodity. It is measured in terms of utils.
(a) Total Utility:- TU is the sum total of satisfaction that the consumer derives when a certain number of units of a particular commodity are consumed. TU = U (b) ar!inal Utility:- U is the additional satisfaction derived from the consumption of an additional unit of the commodity. Un = TUn " TUn-# $lternatively% U&= ' TU&( ')&

"elationship between & and T& : i+ ,hen & is positive T& rises.ii+ ,hen & is -ero T& is ma.imum. Schedule.1 iii+ ,hen & is ne*ative/ T& falls 01ia*ram:1/ Schedule.1+ &N'TS T& & 1 2 2 % 13 4 ( 12 3 3 %5 % 6 %5 5 4 12 7% 1ia*ram:1 1ia*ram:%
Y TU Y

T&8 &

&

9uantity

(-)MU

9uantity

(-)MU

Law o' D%m%n%sh%n" Mar"%na* U(%*%(! : 't states that after consumin* a certain amount of *oods and services the & from it starts decreasin* as more as it is consumed. 0Same Schedule.1/ 1ia*ram: %+ OR
This law is based on followin! assumptions:#. *tandard unit of measurement is used. +. ,omo!eneous commodity. -. .ontinuous consumption. /. ental and *ocial condition of the consumer must be normal. 0. 1o chan!e in income2 tastes2 fashion and price.

Consumer+s e,u%*% r%um: :;uilibrium is a state of rest or a position of no chan*e. A consumer is said to be in e;uilibrium/ when he does not want to chan*e his level of consumption/ i.e. when he derives ma.imum satisfaction.

DHRUV SIRS ECONOMICS CLASSES (9719515194)

So it is a situation where consumer *ets ma.imum satisfaction after consumin* a certain amount of *oods and services with minimum e.penditure. OR The situation when consumer is havin* ma.imum satisfaction with limited income and does not wants to chan*e his e.penditure.
Consumers Equilibrium Single commodity case:It is attained when mar!inal utility of commodity in terms of money becomes e>ual to its price. *ince it is difficult to compare U of a !ood (e&pressed in utils) with its price (e&pressed in =s) therefore U of a !ood is first converted in terms of money by dividin! U of a !ood with MU of a rupee (t e e!tra utility obtained " en an additional rupee is spend on ot er good# : ( U of !ood( U of a rupee) = 3rice of the commodity Units of 8 3rice of 8 (3&) U& # 0 ; u6p + 0 ? 0 0 u=p / 0 / u7p 0 0 U& = 3& ( Um) 3oint 5 (consumer@s e>uilibrium) U63 3oint . (consumer will increase consumption) U73 3oint 4 (consumer will decrease consumption) Consumer Equilibrium in case of t"o commodities Ahen a consumer wants to buy two commodities his e>uilibrium will be determined in accordance with the law of e>ui-mar!inal utility. ,e will distribute his money income amon! these !oods in such a way as he !ets e>ual mar!inal utility in terms of money from all the !oods. In case of two !oods consumer e>uilibrium would be: Unit of U& - !ood (units) Uy - !ood (units) # #/ (#) #B (-) + #+ (+) ; (0) #B (/) ? / ; (?) / 0 ? + ? / B In this case when consumer spends / units of money on &-!ood oney
U& Uy = = 3& 3y ; units ; units = # unit # unit
u& 3& u& = uy 3& 3y = 5 <9 **. * uy 3y 9 T u& 3& * uy 3y

3 r ic e

. u & = 3 & (m u m ) 5 3

u6 3

u7

3 m u&

8
+

Um

and + units of money on y-!ood2 he !ets e>ual mar!inal utility of ; units. Ahen ar!inal utilities are e>ualiCed TU is ma&imiCed. ,ere2 TU = #/D#+D#BD;D#BD; = ?+ units. In no other case2 consumer can !et utility of ?+ units or more than. U& Uy > U& Uy Utility is ma&imum when at point T where2 3& 3y = = Um
3& 3y
$t s o"s t at %& is spent on good ! and %' & on good y( accordingly t e

consumer is at point ) on t e MU! cur*e and at point S on MUy cur*e( & ere is a loss of utility s o"n by t e s aded area( & is prompts t e consumer to transfer some of e!penditure from y to ! till e reac es to point E

: $ : . o m m o d it y

DHRUV SIRS ECONOMICS CLASSES (9719515194)

E . 4 5

Indifference curve: *hows different combination of two !oods that !ive the same level of satisfaction to the consumer. 9=

't is the locus of various points which represent the various combinations of two *oods which *ive e;ual level of satisfaction to the consumer.

8 . o m m o d ity

F o o d -:

: 8

4 5

F ood - &

$ssumptions of I... $nalysis #. =ationality:- ,e would liGe to !et ma&imum satisfaction with !iven income and price. +. 9rdinality:,e can ranG his preferences on the basis of satisfaction of each basGet of !oods. -. 4iminishin! mar!inal rate of substitution:- The rate of substitution of one commodity for another is Gnown as =* = 'y('&. It has always declinin! trend because law of diminishin! mar!inal rate of substitution applies upon consumer while maGin! different combinations. ( =* falls due law of 4iminishin! U) /. There is consistency in consumer@s behave. 0. There is no chan!e in the taste and preferences of consumer. ?. 3rices of !oods and income of the consumer are !iven. H. Monotonic preferences :-$ consumer@s preferences are monotonic if and only if between any two bundles the consumer prefers the bundle which has more of at least one of the !oods and no less of the other !ood as compared to the other bundle. 9= $ rational consumer always prefers more of a commodity as it offers him hi!her level of satisfaction.

DHRUV SIRS ECONOMICS CLASSES (9719515194)

Eud!et *et:- It is a set of bundles of !oods available to the consumer at a !iven price and income. Eud!et constraint:- It shows that a consumer can choose any bundle as lon! as it costs less or e>ual to income and prices of !oods. Eud!et line:- It is the !raphic presentation of all combinations that consumer can buy with his entire income at prevailin! prices. %) Fraphical representation of all possible combination of two !oods which can be purchased with !iven income and prices2 such that the cost of each of these combinations is e>ual to income of the consumer. ( 915: I1.9 5 9I .91*U 5= I* =* +B)

DHRUV SIRS ECONOMICS CLASSES (9719515194)

1. Shifts 'n <ud*et =ine. >ase ' ? ,hen consumers money income increases but prices of commodities remain constant.
'f = is the <ud*et =ine. Suppose if money income is increases then consumer will be able to purchase more *oods with the new income at the *iven prices/ therefore bud*et line will shift to the ri*ht 0= +. Suppose if money income is decreases then consumer will be able to purchase less *oods with the new income at the *iven prices/ therefore bud*et line will shift to the left 0= +. New bud*et line = and =@ @ is parallel to the ori*inal bud*et line = slope of new bud*et lines remain same since price do not chan*e. because

>ase '' ? ,hen prices of *ood A chan*e and income of consumers remain constant.
'f = is the <ud*et =ine. Suppose if price of *ood A falls but money income and price of B *ood remain constant then consumer will be able to purchase more of *ood A only/ therefore bud*et line will shift to the ri*ht 0= +. Suppose if price of *ood A rises but money income and price of B *ood remain constant then consumer will be able to purchase less of *ood A only/ therefore bud*et line will shift to the ri*ht 0= +.

Consumer+s e,u%*% r%um w%(h (he he*- o' In#%''eren&e &ur$e a--roa&h
'n the indifference curve approach/ consumers e;uilibrium is achieved at the point at which bud*et line Cust touches a particular indifference cure/ i.e. the point/ at which the bud*et line is tan*ent to a particular indifference curve. This is the point of ma.imum satisfaction.

A p
Good y

; r D Good .
'>1 '>%

'>(

<

D%a"ram E.-*ana(%on: i+ )A< is the bud*et line.

ii+ 't is sure that consumers e;uilibrium will lie on some point on )A< iii+ 'ndifference map 0set of '>1 / '>% / '>(+ shows consumers scale of preferences between different combinations of *ood ). and *ood )y iv+ >onsumers e;uilibrium will achieve where bud*et line 0A<+ is tan*ent to the '>%.

:ssential conditions for consumers e;uilibrium: i+ <ud*et line must be tan*ent to indifference curve i.e./ "S .y E P. 8 Py ii+ 'ndifference curve must be conve. to the ori*in at the e;uilibrium point. >onsumers cannot achieve the followin*:

DHRUV SIRS ECONOMICS CLASSES (9719515194)

i+ P and )r points on bud*et line *ive satisfaction/ but/ choosin* point ); puts him on a hi*her '> *ives more satisfaction. ii+ #e cannot move on '>( / as it is beyond his money income.