Unit 2- Consumer Equilibrium and demand

Chapter- Consumer Equilibrium- Utility Approach

Concepts:
1. Utility
The term utility refers to the want satisfying power of a commodity. Commodity will possess utility
only if it satisfies a want.
• Utility differs from person to person, place to place, and time to time. So,
• It is relative and subjective in nature.

2. Cardinal Utility: When utility is expressed in exact units or in mathematical terms, it is called
cardinal utility.

3. Ordinal Utility: When utility is expressed in ranks, it is ordinal utility.

X > Y > Z in terms of satisfaction

4. Marginal Utility: It can be defined as the addition to the total utility when one more unit of the
commodity is consumed.

∆ 𝑻𝑼 ∆𝒀
MU= TU n- TUn-1= = = slope of TU curve
∆𝒖𝒏𝒊𝒕𝒔 𝒄𝒐𝒏𝒔𝒖𝒎𝒆𝒅 ∆𝑿

n= total no. of units consumed

∆𝑌 ∆ 𝑻𝑼
slope of curve= = = MU
∆𝑋 ∆𝒖𝒏𝒊𝒕𝒔 𝒄𝒐𝒏𝒔𝒖𝒎𝒆𝒅

5. Total Utility is the sum of the utilities from all the units consumed

TU= MU1 + MU2 + MU3 +…………. + Mun

TU= ∑MU

6. Law of Diminishing Marginal Utility

As we consume more units of a commodity, each successive unit consumed gives lesser
and lesser satisfaction, that is marginal utility diminishes. It is termed as the Law of
Diminishing Marginal Utility.
Intensity of the want ------decreases
 The following utility schedule will make the Law clear.

Unit MU (utils)/ Rate TU (utils)= ∑𝑴𝑼 ∆𝑻𝑼 Relationship

= MU
consumed(orange) of change of TU ∆𝑸 b/w MU and TU
1 10 10 10/1= 10 MU is falling and
2 8 18 8/1 TU is increasing at
3 6 24 6 diminishing rate
4 4 28 4 (MU)
5 2 30 2
6 0 30 0
7 -2 28 -2 TU falling when
Mu is -ve

TU Curve

35 Y-Values Max
30 concave
TU
25
20
15
10
5
0
0 2 4 6 8

Y-Values MU Curve
12
10
Marginal Utility

8
6
4
2
0
-2 0 2 4 6 8 10
-4
Units consumed
 Relationship between TU and MU:

1. TU increases at diminishing rate because MU is falling, but positive. Since TU is increasing at

diminishing rate, it makes it concave.
2. TU is max when MU= 0 (Point of satiety).
3. TU starts falling when MU becomes negative.

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Practice questions
Q1. Complete the table:

Units consumed Total utility Marginal utility

1 7 7
2 - 10
3 - 8
4 31 -
5 - 3
6 34 -
7 - (-)4
Q2. If the consumption of an additional unit of a commodity cause no change in total utility, then
marginal utility will be
a. positive c. negative
b. zero d. maximum

Q3. Satiety point refers to a situation where in

a. TU is rising and MU is falling c. TU is falling and MU is negative
b. TU is maximum and MU is zero d. Falling MU curve

Q4. The TU from 9 units of commodity- X is 20 and from 10 units is 15. Calculate the MU from 10th unit.
Q5. The MU from the consumption of commodity- X is given below, calculate TU.

Units of X 1 2 3 4 5
MUx 10 9 7 3 -5
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Consumer Equilibrium- UTILITY APPROACH

Q1. Given the market price of the commodity, how does a consumer decide as to how many units of
that good to buy? Explain.

OR
How does a consumer reach equilibrium position when he is buying only one good? Explain with
the help of marginal utility schedule.
OR
Explain how the price which consumer is willing to pay for a good equals the marginal utility of that
good.
OR
How many units of a commodity should a consumer buy to get maximum utility? Explain with the
help of a numerical example.

Ans. Meaning of consumer equilibrium

Consumer equilibrium refers to situation when consumer distributes his limited money income
amongst various goods and services in such a way that he derives maximum satisfaction from the
given expenditure and has no tendency to change it.

Assumption of consumer equilibrium

1. Utility can be measured i.e. it can be measured in exact terms. It can be measured in monetary
terms.
2. Consumer income is given and constant.
3. Prices of commodities are given and constant.
4. Marginal utility of money remains constant. It means that importance of money remains
unchanged.

Condition of consumer equilibrium- Single commodity

1. MU of good X in terms of money = Price of the commodity

MUx (Rs)= Px
𝑴𝑼𝒙
= Px
𝑴𝑼𝒎

MU (utils) > Px (Rs)—D increase

MU< Px---- D decrease
MU = Px---D increase
 Marginal utility of money refers to utility that the consumer expects to obtain from a standard
basket of goods which he or she can buy for a rupee. Example: if a rupee can buy 100 g of sugar
and 500 g of rice (which represents a standard basket of goods to the consumers) and if the
total utility from these goods is 4 utils, then 4 is to be taken as marginal utility of money.

MU m = 4 utils

1Rs = 4 utils

How to convert utility in utils into money (Rs)?

1 Rs= 4 utils (MU m)

8 𝑢𝑡𝑖𝑙𝑠
Suppose consumption of commodity X gives satisfaction of 8 utils= Rs 2= = Rs 2
4 𝑢𝑡𝑖𝑙𝑠=

2. Total gains fall as more is purchased after equilibrium.

Explanation of the conditions

1. MU(Rs) = Price
Consumer will buy the commodity only if marginal utility (in terms of money) obtained from the
commodity is greater than the price of the commodity. While purchasing a commodity, consumer
compares the price of the commodity with its expected utility i.e consumer compares the benefit
with the price payable. Consumer will buy the commodity only when utility from that unit exceed
or at least equal to the price paid. He will not consume anymore if utility obtained is less than price
paid.

This can be explained with help of a schedule

Let MU of ₹1 be 1 util, (1Rs = 1util)

Consumption T.U M.U 𝑴𝑼𝒖𝒕𝒊𝒍𝒔 Market Gain per unit Total gain
(units) (utils)= (utils) 𝑴𝑼𝒎 price, in terms of
∑MU = 𝑴𝑼𝒙 (𝑹𝒔) Px (Rs) utility

0 0 0 0 Rs 10 - -
1 15 15 utils Rs 15 > Rs 10 Rs 5 Rs 5

2 28 13 utils Rs 13 > Rs 10 Rs 3 5+3= Rs 8

3 38 10 Rs 10 = Rs 10 0 Equilibrium Rs 8
utils
4 44 6 utils Rs 6 < Rs 10 -4 Rs 8+ (-4)= Rs 4

Gains per unit= column 3 – column 5

 In the above schedule equilibrium is achieved at 3 unit of consumption where MU in terms of
money is equal price of the commodity or where gains are maximised. The difference between the
utility and price of the commodity represents gains. Consumer maximises gains when MU( in terms
of money) = price.

3. Total gains falls as more is purchased after equilibrium.

It means that consumer will continue to buy so long as gain is increasing or atleast constant. If
consumer buys 4th unit then total gains falls, therefore, he will buy till 3rd unit of commodity only.
The purchase of 3rd unit satisfies both the condition.

Q2. A consumer consumes only two goods. Explain his equilibrium with the help of utility analysis.

OR
A consumer consumes only two goods, what are the conditions of consumer equilibrium in utility
approach? Explain the changes that will take place when consumer is not in equilibrium.

Ans2. Meaning of consumer equilibrium

Consumer equilibrium means that allocation of income, given the prices, by the consumer on goods
and services he buys, which gives him maximum satisfaction.

In reality consumer spends his money income on many goods. In such a case the law of diminishing
marginal utility is extended to many goods which the consumer buys with h.is income. A consumer
allocates his expenditure on all goods in such a way that utility derived from the last rupee spent on
each commodity is equal. This is called as Law of Equi marginal utility.

Condition of consumer equilibrium:

𝑴𝑼𝒙 𝑴𝑼𝒚
1. = = 𝑴𝑼𝒎
𝑷𝒙 𝑷𝒚
 𝑀𝑈𝑥 𝑀𝑈𝑦
=
𝑃𝑥 𝑃𝑦
12 𝑢𝑡𝑖𝑙𝑠 9 𝑢𝑡𝑖𝑙𝑠
=
𝑅𝑠 4 𝑅𝑠 3

3 utils/Rs 1= 3 utils/ 1Rs

2. MU of a good falls as more of it is consumed (The Law of Diminishing marginal utility)

Explanation:
𝑀𝑈𝑥 𝑀𝑈𝑦
1. = (Law of Equi-marginal utility)
𝑃𝑥 𝑃𝑦
Consumer is in equilibrium at the level of consumption where above condition is satisfied i.e. where
marginal utility of last rupee spent on each commodity is equal.
Meaning of marginal utility last rupee spent on each good—suppose a consumer purchase 5 units
of a good at the price of ₹ 4 per unit. Further suppose that last unit gives satisfaction of 8 utils to
the consumer. So, on an average MU of last rupee spent on the commodity is 2 utils (8/ 4).

What happens when equilibrium condition is not satisfied?

𝑴𝑼𝒙 𝑀𝑈𝑦
CASE1- >
𝑷𝒙 𝑃𝑦
It means that marginal utility of last rupee spent on commodity X is greater than MU obtained from
last rupee spent on Y. This induces the consumer to shift the expenditure from the purchase of
commodity Y to commodity X. The consumption of X rises while of Y decreases. In this process, MU
of X falls while of Y increases. This results in decrease in ratio MU x/ P x while MU y/ P y rises. This
process continues till the two ratios become equal and equilibrium is achieved.

𝑴𝑼𝒙 𝑀𝑈𝑦 Utility derived by spending Law of DMU operates, utility

>
𝑷𝒙 𝑃𝑦 a unit of money on Good X of X decreases whereas
is more than Good Y, As a 𝑴𝑼𝒙
16 𝑢𝑡𝑖𝑙𝑠 9 𝑢𝑡𝑖𝑙𝑠 utility of Y increases,
𝑷𝒙
> result consumer will spend
𝑴𝑼𝒚
𝑅𝑠 4 𝑅𝑠 3 falls, rises
more on Good X than on
𝑷𝒚
4 utils/1Rs > 3 utils/ 1Rs Good Y

This process continues till

𝑴𝑼𝒙 𝑀𝑈𝑦
=
𝑷𝒙 𝑃𝑦
 𝑴𝑼𝒙 𝑀𝑈𝑦
CASE 2- <
𝑷𝒙 𝑃𝑦

12 𝑢𝑡𝑖𝑙𝑠 21𝑢𝑡𝑖𝑙𝑠 Consumer will spend more on Good-Y as utility

< derived by spending a unit of money on it is
𝑅𝑠 4 𝑅𝑠 3
more than utility derived per unit of money by
3 utils < 7 utils spending on Good-X

𝑴𝑼𝒚 𝑴𝑼𝒙 Consumer increases consumption of Y

falls, rises, this process and decreases of X, Law of DMU
𝑷𝒚 𝑷𝒙
𝑴𝑼𝒙 𝑀𝑈𝑦 operates, utility of Y decreases (MUy)
continues till = whereas utility of X increases (MUX)
𝑷𝒙 𝑃𝑦

𝑀𝑈𝑦
= 18/ Rs 3= 6 utils
𝑃𝑦
= 15/ Rs 3= 5utils

𝑴𝑼𝒙 𝟏𝟔
- = = 4 utils
𝑷𝒙 𝟒

2. MU of a good falls as more is consumed.

This condition is nothing but the assumption that law of diminishing marginal utility is in operation.
It is because of the reason that if law of diminishing marginal utility is not in operation then Law of
equi- marginal utility may not be realised.

Q3. Ice cream sells for ₹ 30. Laksmmi, who loves ice cream has already eaten 3. Her marginal utility
from eating 3 ice creams is 90. Suppose for her MU of one rupee is 3. Should she eat more or stop?