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CONSUMER’S EQUILIBRIUM
Consumer is one who buys goods and services for satisfaction of wants. He takes decision with regard to the kind of goods to be purchased in order to satisfy his wants. Types of approach Cardinal utility approach (or marshall’s utility analysis or marginal utility analysis) Ordinal utility approach (or indifference curve analysis or Hicksian analysis) a. CARDINAL UTILITY APPROACH Utility- Utility refer to want satisfying power of commodity. Total Utility- Total utility refer to the total satisfaction obtained from the consumption of all possible units of a commodity. Example. Unit of ice cream Unit of ice cream Total utility 1 10 2 8 3 6 4 4 5 2
As per above example Total utility = 10+8+6+4+ Total utility= 30 Marginal Utility-Marginal utility is the additional utility derived from the consumption of one more unit of the given commodity. MU= TUn – TU(n-1) TOTAL UTILITY IS SUMMATION OF MARGINAL UTILITY TU=∑MU TABLE ICE CREAM CONSUMED MARGINAL UTILITY TOTAL UTILITY 1 20 20 2 16 36 3 10 46 4 4 50 5 0 50 6 -6 44
Relationship between TU and MU
- TU increases with an increase in consumption of a commodity as long as MU is positive, that is till the 4th^ ice-cream. In this phase, TU increase, but a diminishing rate as MU from each successive unit tends to diminish.
- When TU reaches its maximum, MU become zero,that is when 5th^ ice-cream is consumed. This is known as point of satiety. TU curve stop rising at this stage.
- When consumption is increased beyond the point of satiety, TU start falling as MU become negative. LAW OF DIMINISHING MARGINAL UTILITY Law of diminishing marginal utility state that we consume more and more unit of a commodity, the utility derived from each successive unit goes on decreasing.
As per graph we can see as we consume more and more quantity of the goods utility derived from each successive unit keep on decreasing. Utility derived from A’ is giving more satisfaction than utility that we get from E’. .
GRAPH
The diagram above shown after every consumption the marginal utility falls. CONSUMER’S EQUILIBRIUM Consumer’s equilibrium refers to the situation when a consumer is having maximum satisfaction at minimum level of income and has no tendency to change his way of existing expenditure. Basically MU=P Here marginal utility is equal to the price Condition’s Equilibrium in case of single commodity Consumer purchasing a single commodity will be at equilibrium, when he is buying such a quantity of that commodity, which gives him maximum satisfaction. The two factors are
- Price of the given commodity
- Expected utility (marginal utility) from each successive unit. Unit Price MU Difference MU and price
MU of price Remark 1 10 20 20/1=20 20-10=10 MU>P 2 10 16 16/1=16 16-10=6 MU>P 3 10 10 10/1=10 10-10=0 MU=P 4 10 4 4/1=4 4-10=-6 MU<P 5 10 0 0/1=0 0-10=-10 MU<P 6 10 -6 -6/1=-6 -6-10=-16 MU<P At unit 1 and 2 the marginal utility is more than the price At unit 3 marginal utility of the commodity is equal to the price At unit 4,5 and 6 the marginal utility is less than the price Consumer’s equilibrium in case of two commodity Mux/Px=MUy/Py=Mum
ORDINAL UTILITY APPROCH (INDIFFRENCE CURVE ANALYSIS OR HICKSIAN ANALYSIS)
The real elaboration of indifference curve was made by J. R. Hicks and R. G. D. Allen, popularly known as Hicks and Allen. In 1934, they wrote article, ‘A reconstruction of the theory of value’ presenting the Indifference curve analysis. Modern economists disregarded with the concept of ‘cardinal measure of utility’. They were of the opinion that utility is a psychological phenomenon and it is next to impossible to measure the utility in absolute term. For example, if a consumer two goods, apples and bananas, then he can indicate:
- Whether he prefer apple over banana
- Whether he prefer banana over apple Whether he is indifferent between apple and banana, i.e. both are equally preferable and both of them give him same level of satisfaction. MEANING OF INDIFFERENCE CURVE INDIFFERENCE CURVE REFERS TO THE GRAPHICAL REPRESENTATION OF VARIOUS ALTERNATIVE COMBINATIONS OF BUNDLES OF TWO GOOD AMONG WHICH THE CONSUMER IS INDIFFERENT COMBINATIO N
APPLE BANANAS
P 1 15
Q 2 10
R 3 6
S 4 3
T 5 1
As seen in the schedule, consumer is indifferent between five combinations of apple and banana. All the different combination give same level of satisfaqction. MONOTONIC PREFRENCE MONOTONIC PREFRENCE MEANS THAT A RATIONAL CONSUMER ALWAYS PREFERS MORE OF A COMMODITY AS IT OFFER HIM A HIGHER LEVEL OF SATISFACTION..IN SIMPLE WORD, MONOTONIC PREFRENCE IMPLIES THAT AS CONSUMPTION INCREASE TOTAL UTILITY INCREASE.
5. RATIONAL CONSUMER- Consumer is assumed to behave in a rational manner, i.e. he aims to maximise his total satisfaction. **PROPERTIES OF INDIFFERENCE CURVE
- INDIFFERENCE CURVES ARE ALWAYS CONVEX TO THE ORIGIN:** An indifference curve is always convex to orgin due to MRS 2. INDIFFERENCE CURVE ALWAYS SLOPE DOWNWARD- It mean consumer consume more of one good,he must consume less of the other goods 3. HIGHER IC GIVE HIGHER LEVEL OF SATISFACTION – Higher IC large number of goods which will represent higher level of satisfaction because of the monotonic prefrence 4. IC CURVE NEVER INTERSECT EACH OTHER- As two IC never intersect each other which basically mean it does’t give same level of satisfaction and they cannot intersect each other. Budget line All the possible combination of goods which a consumer can purchase in given set of income. Budget set Budget set is the set of all possible combinations of two goodas which consumer can afford, in the given set of income and price of the market TABLE Combination of A and B
Apple ( ruppe) A
Banana (2ruppe) B
Money spent=income E 5 0 (54)+(02)= F 4 2 (44)+(22)= G 3 4 (34)+(42)= H 2 6 (24)+(62)= I 1 8 (14)+(82)= J 0 10 (04)+(102)=
ALGEBRIC EXPRESION M=(P OF A * QUANTITY OF A)+(PRICE OF B * QUANTITY OF B) PROPERTIES OF BUDGET LINE
1. DOWNWARD SLOPING – Budget line is negative slope that is more of apple decrease the quantity of banana 2. STRAIGHT LINE - Slope represent budget line as it represent price ration as price ratio remain constant SHIFT OF BUDGET LINE 1. CHANGE IN INCOME- The change in income will shift the budget line. LEFT SHIFT decrease in income and RIGHT SHIFT increase in income 2. CHANGE IN PRICE OF THE COMODITY- If there is a change in price of the goods the budget line also if shift- Suppose price of apple change the budget line from the end of banana will be fix where as from that point the line going to apple it will shift either left or right depending on price increase or decrease if
increases line shift on X axis vtowards right side and if price got decreased the line shift on X axis is towards left side.
