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Consumers equilibrium

By Dr Naheed Sultana

Utility.
The power of a product to satisfy
human wants is called utility
The value a consumer places on a
unit of a good or service depends on
the pleasure or satisfaction he or she
expects to derive form having or
consuming it

Total Utility: The aggregate level of


satisfaction or fulfillment that a
consumer receives through the
consumption of a specific good or
service, it is sum of marginal utilities
Marginal Utility: Marginal utility is
the utility a consumer derives from
the last unit of a consumer good he
or she consumes

Rational consumer
Consumers are utility maximizers
Consumers prefer more of a good to less of
it.
A consumer would either prefer X to Y or Y to
X, or would be indifferent between them.
Transitivity: If a consumer prefers X to Y and
Y to Z, then X is preferred to Z
Assumption of cardinal approach to utility or
utility is measured in terms of Utils

Law of diminishing MU
The "Law of Diminishing Marginal
Utility" states that for any good or
service, the marginal utility of that
good or service decreases as the
quantity of the good increases,
ceteris paribus. In other words, total
utility increases more and more
slowly as the quantity consumed
increases.

TU

MU

180

160

45

45

85

40

140
120

120

35

140

20

100

150

10

80

157

60

160

40

160

20

155

-5

0
1
-20

10

Consumers equilibrium
No of
units

MU I

MU B

45

60

40

55

35

50

20

30

10

15

-5

-5

-10

Suppose consumer is
consuming two products ice
cream and burger. The price of
Ice cream is Rs.20 and price of
burger is Rs. 30
Suppose utility of one rupee is
2 utils
Consumer will consume two
units of Ice cream and one unit
of burger
If price of Ice cream reduces to
Rs.10 and of Burger to Rs 25
the consumer will increase the
consumption of Ice cream to 4
units and of burger to 3 units

The rational spending rule


Spending should be allocated across
goods so that the marginal utility per
rupee is same for each good or
Mua/Pa =Mub/Pb
As we have seen that reduction in
price increases consumption, so we
can derive law of demand with the
help of consumers equilibrium

Ordinal approach of consumers


equilibrium
According to Slutsky and Hicks we
cant measure utility in terms of Utils
We can only arrange utility of
different consumption bundles in
terms of preferences
A > B or B>A

Indifference schedule

The indifference curve

Indifference curve

Marginal Rate of
Substitution

Marginal rate of Substitution


Combinations

Apples

Mangoes

MRS

15

11

4:1

3:1

2:1

1:1

Law of Diminishing MRS


AS more and more
of one good is
consumed along an
indifference curve,
the consumer is
willing to give up
less and less of
some other good to
maintain the
satisfaction level

Indifference Map
Y
Slope = Change in Y/Change in X
= MUx/MUy

U4
U3
U2
U1
O

Indifference Map

Properties of Indifference
curves
Indifference curves for two goods are generally
negatively sloped
The slope of an indifference curve reflects the
degree of substitutability of two goods for one
another
Indifference curves are generally convex,
reflecting the principle of diminishing returns
Indifference curves never cross
Indifference curves that are farther from the
origin represent higher levels of utility
Indifference curves for a good and a bad are
positively sloped

Budget Line
A consumers budget line shows the
combination of goods that can be
purchased with a given money
income and prices of goods held
constant
Suppose consumer is purchasing X
and Y with income I, budget
constraint is
I=PxX + PyY or 10X +5Y= 100 then
X is 10 when Y is 0 and Y is 20 when

Budget Line
Y
Income = Px .Qx + Py. Qy
I/Py

Slope = Px/Py

X
O

I/Px

Shifting of B.L
Whenever there is
increase in income
consumer can
purchase more of
both goods
therefore budget
line shifts to the
right

Change in Price of X
When price of X
decreases
consumer can buy
more of X in given
income so X
intercept increases
and there is
change in slope of
budget line

Assumptions of equilibrium

Consumers equilibrium

In the diagram there are 4 IC curves


representing utility of U1, U2, U3 and U4. the
consumer can not achieve U4 as it is out of
budget line. Consumer must be at the budget
line.At point a utility level is U1 if consumer
changes the combination and increases the
consumption of X utility increases to U2 . The
consumers satisfaction is maximum at point
c where budget line is tangent to IC or
slope of IC= slope of BL

Slope of IC:
U=f (X,Y)----U=U/ X* dX + U/ y*dy=0
Or Mux*dX + Muy*dy =0
Mux*dX= -Muy*dy
dY/dX = - MuX/Muy = MRS
Slope of BL
PxX+PyY=I, Y= I/Py Px/Py*X
dY/dX = -Px/Py

In equilibrium the slope of IC is equal


to slope of BL so we can right
equation of consumers equilibrium
as follows
MuX/MuY= -Px/Py
MRS= - Px/Py

A change in the price of X: Income and


substitution effects
Y

a
b
Y1
Yo

U5

U4

c
U3

d
e
O

Xo

X1

U2
U1

A change in the price of X: Income and


substitution effects
Y

a
b
C
Y1
Yo

U5
U4

U3

d
e
O

Xo

X1

U2
U1