Chapter 2.

Theory of Consumer Behavior and Demand

Introduction: - As a consumer, we take numerous decisions in our

daily life: should we take tea or coffee in the morning? Should we carry
lunch packet or take lunch in the cafeteria?

The way consumers take decisions on such problem is called

consumer’s decision - making behavior. By consumer behavior is
meant how consumers decide on the basket of goods and services
they consume. People demand goods and services because they
satisfy the wants of the people and the economists assume that
consumer is a utility maximizing entity.

Utility means a want satisfying power of a commodity. It is also defined

as property of the commodity, which satisfies the wants of the
consumers. Utility is a subjective entity and resides in the minds of
people. Being subjective it varies with different persons, that is
different persons derive different amounts of utility from a given good.
The desire for a commodity by a person depends on the utility he
expects to obtain from it. The greater the utility he expect from a
commodity, the greater his desire for that commodity. In studying the
behavior of consumers, economists assume the following about
consumers of economic goods and services:

a. Objective of the consumer is maximization of utility- its

assumed that consumers are utility maximizes. As an economic
agent consumer is assumed to have only the objective of
optimizing utility that can be derived from the consumption of
goods and services.
b. Consumers are subject to constraint – as an economic
agents and optimizer of utility consumers constrained by the size
of their income and prices of goods & services.

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 c. Rationality of consumers - consumers are assumed to be
rational beings. He/she can reason out as to what is good and
what is bad for him and he prefers more of good to less of it
further more he aims at the maximization of his utility subject to
the constraint imposed by his income .

Approaches to the analysis of consumer Behavior

There are two main approaches to the analysis of consumer behavior:

i) Cardinal utility approach and ii) Ordinary utility approach

2.1 Cardinal Utility Theory (CUT )

Cardinal utility theory is based up on certain important assumptions.

i. Utility is measurable: - The utility of each commodity can be

measured in absolute terms. For instance a person can say that from
consumption of commodity X, he derives 10 utils of utility and from
commodity Y, he drives 5 utils of utility & so on…. According to
Marshall, money is a measuring rod of utility. Marshall argues that the
amount of money that a person is prepared to pay for a unit of good
rather than go without it is a measure of the utility he derives from
that good.

ii. The marginal utility of money is constant: - This assumption is

necessary if monetary unit is used as the measure of utility. Marginal
utility of commodities diminish as more of them are purchased or
consumed, but the marginal utility of money remains constant
throughout when the individual is spending money on a good and due
to which the amount of money with him varies.

iii. The Law diminishing marginal utility: - the utility gained from
successive units of a commodity goes on diminishing as the consumer

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consumes more of it. That is, the additional benefit or marginal utility a
person derives from a given increase of quantity consumed of a
commodity diminishes with every increase in quantity.

iv. Utility is additive - total utility from consumption of different

baskets of goods obtained by adding utility from each basket of good.

Total and marginal utility Concepts

The concept of cardinal utility makes it possible to define the total and
marginal utility in quantitative terms.

Total utility (TU):- may be defined as the sum of the utility derived
from all the units consumed of the commodity. if there ‘n’ number of
commodities ; such as X 1 , X 2 , … , X n , total utility is the sum of utility
obtained from each commodity.

TU =U 1+ U 2+ U 3 +… …+U n , if the consumes n unites.

Marginal utility(MU) – is the addition to the total utility deriving from

the consumption or acquisition of one additional unit; or it is the
change in the total utility resulting from the change in quantity
consumption of a commodity/ good. That is,

MU =ΔTU / ΔQ

Where ∆TU = change in total utility, ∆Q = change in quantity consumed of a

good or service. Marginal utility indicates how TU changes in response to
change in quantity consumed.

Numerical Example:-Table 2.1 presents a numerical illustration of the

law of diminishing marginal utility. As the table shows total utility
increases with increase in consumption of sandwiches, but at a
decreasing rate. It means that MU decreases with increase in quantity
consumed. This is shown in the last column of the table.
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 Table 2.1 total and marginal utility
Q- TU MU
In the table, the total utility reaches maximum at 67
quantity
at the 5th unit consumed; Here, MU = 1.
th
0 Consumption0 of 0the 6 unit yields negative utility
and the total utility starts declining.
1 30 30
2 50 20
3 60 10
4 66 6
5 67 1
6 66 -1

Graphical illustration: - the law of diminishing marginal utility is

graphically illustrated in Fig 2.1 (a) and (b). By plotting the data given
in table 2.1 total utility curves goes on raising still the 5 th unit
consumed. Beyond the 5th unit the TU curve start fall and it shows
decrease in the MU

. TU
Maximum TU
67

TU
60

50

30

4
 0 1 2 3 4 5 6 Quantity
consumed

Fig 2.1A.
Total Utility
MU

30 MU curve
Fig 2.1B. Marginal
Utility
20

10

0 1 2 3 4 5
6 Qx

Fig 2.1 Total Utility Marginal Utility

 Theoretically, TU reached maximum when MU is approximately

becomes zero.
 MU curve is downward sloping, or has a negative slope indicating
the inverse relation between MU derived and quantity consumed of a
good.
 Up to the fifth unit MU is decreases with successive consumption
but still positive; and TU utility is increasing. This decrease in MU
with the successive consumption indicates the Law of DMU.
 Starting from the 6th unit MU is negative, and TU starts to fall.

The Law of Diminishing Marginal Utility (LDMU) - The axiom or

law of diminishing marginal utility is central to the cardinal utility
analysis of the consumer behavior. The axiom or law postulates
decline/diminishing marginal rate of substitution among goods.

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This law states that as the quantity consumed of a commodity increase
over a unit of time, the utility derived by the consumer from successive
units goes on decreasing provided the consumption of all other goods
remain constant. In other words, as a consumer takes more units of a
good the extra utility or satisfaction that he derives from an extra unit
of the good goes on falling.
Law of diminishing marginal utility holds only under certain given
conditions. These conditions are

I. The good in consumption has to be standard, i.e., has to same

quality, size or in any other dimensions otherwise the law may
not hold.
II. Consumer’s taste or preference must remain unchanged
during the period of consumption.
III. There must be continuity in consumption and where break in
continuity necessary, it must be appropriately short.
IV. The mental condition of the consumer must remain normal
during the period of consumption of a commodity.

Consumers Equilibrium: - Cardinal Utility Theory/ Approach

(CUT)
As mentioned earlier, a consumer is assumed to be a utility maximize.
A consumer reaches equilibrium position, when he maximizes his total
utility given his income and prices of commodities he consumers.
Analyzing consumer’s equilibrium requires answering the question as
to how a consumer allocates his money income among the various
goods and services he consumes.

Consumer equilibrium:- one commodity case - We being with the

simple model of a single commodity X. the consumer can either buy
some quantity of good X or retain his money income, M. under these

6
conditions the consumer is in equilibrium when the marginal utility of X
( MU x ¿ is equated to its market price ( P x). Symbolically we have:

a. MU x =P x ,
b. Given the budget constraint is satisfied; M = X P x .
If MU x > Px , the consumer can increase his well fare by purchasing more
units of X.
Similarly if MU x < P x the consumer reduces quantity of good X to
increase total utility and keeping more of his income unspent.
Therefore, he attains the maximization of his utility.
When MU x = P x. When only a single or type of commodity is consumed

Equilibrium when more than one commodity is consumed (CUT)

- If there are more commodities, the condition for the equilibrium of
the consumer is the equality of the ratio of the marginal utilities of the
individual commodities to their respective prices. Suppose we have
two commodities X and Y to be consumed by a consumer with prices
and marginal utilities: P x, MU x ;∧P y ∧MU y respectively. The consumer
equilibrium conditions would be stated as:

MU x MU y
A. ¿
Px Py

B. The budget constraint is: ¿ X P x +Y P y ; M – total income

The utility derived from spending on additional unit of money must be

the same for all commodities. If the consumer derives grater utility
from any one commodity, he can increase his welfare by spending
more on that commodity and less on the others, until the above
equilibrium condition is fulfilled.
Numerical Example;- suppose the utility function for two goods X
and y is given below;
 U (x , y)=4 Xy− y 2 ; MUX = 4y and MUy = 4x - 2y
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  Subject to budget constraint: 2 x+5 y =110 (note;
P X=birr 2∧Py=birr 5 ¿ .
MU x MU Y
Soln: equilibrium condition: =
Px Py
4 Y 4 X−2 Y
=
2 5
8X - 4Y = 20Y
8X = 24Y and X =3 Y
Substituting this into budget equation; we have: 2(3 Y )+5 Y =110;
Hence, 11Y =110 ,∧Y =10 units. Since X =3 Y ∧X =3∗10=30 units ;

Therefore, the optional choice of the consumer is x=30 units ,∧ y=10 units

Derivation of demand of the consumer under CUT - the demand

curve is derived from the MU curve based on the axiom of diminishing
marginal utility. The LDMU states that as quantity consumed increases,
marginal utility derived from consumption of a commodity will
decreases. The downward sloping of MU curve shows the LDMU.

MU

MUx

0 D Good X

Fig 2.2 MU curve

Accordingly the marginal utility declines continuously and become
negative beyond point D. If the marginal utility is measured in
monetary units; the demand curve for the commodity is identical to
the positive segment of the marginal utility curve (segment between
points R and D).
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 Thus, under CUT the demand curve for a commodity is derived from
the positive segment of the MU curve (segment RD in the fig above).
 The LDMU and MU curve are the basis for the derivation of the law of
demand.
Consumers always pay a price for each good based the MU per unit of
a good. For a higher MU, consumers pay high prices; similar a low MU
pay low price unit of good.
In fig 2.3 below;
 At X1 units the marginal utility is MU1, and the price paid is p1. From
the perspectives of consumers MU1 = P1. By implication, at P1 the
consumer demands X1 units of the product.
 Similarly at X2 the marginal utility is MU 2 and is equal to the price
P2. Hence at P2 the consumer will buy X2 units, and soon.
 At X3, marginal utility is MU3 and consumers willing to pay a price,
P3.
MU
R A where MU1 = P1
MU1
MU2 B where MU 2 = P2
MU3 C where MU 3 = P3
D QX
0 X1 X2 X3 MUx
Fig 2.3 MU curve
Note also that;
 MU 1> MU 2 > MU 3 and P1 > P2 > P3 – high MU corresponds to high price
 X 1 > X 2> X 3 and MU 1> MU 2 > MU 3 - lower quantity corresponds with high
MU
 From the two conditions we conclude lower quantity demanded
corresponds with higher prices, that is, X 1 , X 2 , X 3 corresponds with
P1 , P2 , P3 ,respectively.

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Taking points R , A, B, C and D from the above figure with the corresponding
prices and quantities , we derive and draw the demand curve of the product
as follows.
PX  The negative section of the MU curve
R does not form part of the demand curve
(Segment beyond point D), since negative
P1 A quantities do not make sense in
economics.
 Similar to the MU curve, the DD curve is
P2 B
downward sloping (has -ve slope)
p3 C reflecting inverse relation between
DD
0 X1 X2 X3 D Qx
Fig 2.4 Demand curve derived from MU curve
Critiques of cardinal approach
The following are some basic weaknesses of the cardinal utility theory.
I. The assumption of cardinal approach that utility is cardinally or
objectively measurable is. Utility is a subjective concept, which
cannot be measured objectively.
II. The assumption of constant marginal utility of money is used
because money serves as a measure of utility. However, this
assumption is unrealistic b/c marginal utility of money, like that of
all other goods is subject to change and therefore it cannot serve
as a measure of utility derived from goods and services.
III. The psychological law of diminishing marginal utility has been
established from introspection. The law is accepted as an axiom
without empirical verification.

2.2 Ordinal Utility Theory/Approach (OUT)

Unlike the cardinal utility theory, the ordinal utility theory stated that
utility is not measurable. It asserted consumer can only rank or order
the utility he/she derives from different goods. The theory uses

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indifference curve (IC) in analyzing the consumer behavior, hence
referred as Indifference curve theory/approach.

This theory provides another method of studying the consumer’s

behavior, since it uses indifference curves [IC] to study the consumer’s
behavior, the ordinal utility theory is also known as the indifference
curve approach.

The OUT rejects the view that utility is measurable objectively because
utility is a subjective concept it can’t be measured objectively or
cannot be expressed numerically. The theory argued utility is an
ordinal magnitude – that is – consumers can only rank or order utility
derived from the consumption of different goods.
Good Y good Y

IC3
IC
IC2
IC 1
good X
good X
Indifference curve , IC Indifference map
Ordinal utility is not quantity or a numerical value. It is only an
expression of ranking or ordering consumer’s preference for one
commodity over another.
The concept of ordinal utility is based on the following axioms (Rule of
principle)
a. It is not possible for a consumer to express his/her utility in
quantitative terms. But it is always possible for him/her to tell which of
any two goods he prefers.
b. In view of this the consumer can order all the commodities he
consumes in the order of their preference.

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In the opinion of the ordinals, this is sufficient to analyses consumer
behavior, and absolute measurement of utility is nether neither
feasible nor necessary for analyzing consumer behavior.
Assumption of ordinal utility theory - the theory makes the
following assumptions;
1- Rationality:- the consumer is assumed to be rational, he aims at
the maximization of his utility given his income and market prices. It is
assumed he has full knowledge of all relevant information.
2- Utility is ordinal: - utility is ordinal magnitude; it can’t be
measured or expressed numerically. Consumers can rank or order their
preferences from consumption of different baskets of goods according
to the satisfaction of each basket. It is difficult to numerically /objective
measure utility for consumers. They need not know precisely the
amount of satisfaction, it is enough somehow the compare and rank
utility from different goods.
3- Consistency and transitivity of choice:- it is assumed that
consumers are consistent in their choice, that is, if in one period he
chooses bundle A over B he will not choose B over A at another period
if both bundles are available to him. The consistency assumption may
be symbolically written as follows: If A> B , then B< A .
Similarly, it is assumed that consumer’s choice is characterized by
transitivity: if bundle A is preferred to B, and B is preferred to C, then
bundle A, is preferred to C, symbolically we may write the transitivity
assumption as follow; If A> B ,∧B>C then A>C .
4. Law of Diminishing Marginal Rate of Substitution (Law of
DMRS).
The marginal rate of substation (MRS) is the rate at which a consumer
is willing to substitute one commodity (X) for another (Y) without
changing or affecting total utility. The Rate is given by ∆Y/∆X. the
assumption of DMRS/ diminishing marginal rate of substitution, is that,
∆Y/∆X goes on decreasing, when a consumer continue substitute X for

12
Y. in other words, DMRS refers to the increasingly difficulty one face in
substituting one commodity for another without affecting TU.
The law of DMRS states that the rate at which one commodity is
substitute to another decreases as one keep on increasing
consumption of one commodity while at the same time reducing
quantity consumed of the other commodity.
2.2.1 Nature of Indifference curve (IC)
An Indifference curve is the locus of points, each representing a
different combination of two goods, which yield the same utility or
level of utility. IC is a curve that shows the different combinations of
two goods (say goods X and Y) that give the same level of utility. On IC
 An IC contains
consumers can choose between any combinations
infinite no. ofof goods
points without
or combinations
of goods X and Y. such as combinations A, B, C and D.
affecting total utility.  Since all points (A, B, C, D , ETC) are on the same IC ,
good Y represent the same amount of utility.
 At points A and D we different combinations of X and
100 .A (X= 5, y= 100) Y, but level of utility is same for both.

.B
.C
10 .D( X = 50, Y=10)
IC

0 5 50 good X
Indifference curve, IC (convex in shape)
Indifference curves are also called iso- utility curves [equal utility
curves]. For example: let us suppose that commodity X and Y are
substitute to each other and combinations; A, B, C, D, of the two
commodities, as presented in table 2.2. Since all combinations on an
IC yield the same level of satisfaction, consumer is indifference
between any of the possible combinations.
Table 2.2 Indifference schedules of commodities X and Y.

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Combination commodity Y commodity X
utility
A 20 5
U
B 15 12
U
C 10 20
U
D 5 30
U

It shows various combination two goods yielding the same degree of

satisfaction or utility.

Combinations: A, B, C, D given in table

2.2 plotted and joined by a smooth
Commodity Y

20 A curve, the resulting curve known as

indifference curve(IC).
*The IC is convex in shape – because of
LDMRS. The MRS between X&Y is
15 B
10 C

15 D IC
0 5 12 20 30 Commodity X
Indifference curve (convex in shape)
The MRS (marginal rate of substitution) is the rate at which one
commodity can be substituted for another, the level of satisfaction
remaining the same.
The MRS between two commodities, X and Y may also be defined as
the ratio of quantities of X and Y required replacing one for another
under the conditions that total utility remains the same. It implies that
the utility of units of X given up is equal to the utility of additional units
of Y. Suppose moving from point A to B, MRS between X and Y is
computed as

14
MRS x, y = |−∆∆ XY |= |−57| = 5/7 = 0.714

Which could be interpreted as; the MRS of X for Y between A and B is

0.714 on average. This means one unit of x can be substituted for
0.714 unit of Y to keep the level of on the same IC or to keep total
utility constant. In other words, the utility from 5 units of is equal to
utility from the consumption of 7 units of X.
Note that MRS is the slope of IC between any two points;

MRSx,y = slope of IC = |−∆∆ XY |

To explain symbolically the concept of MRS, let us suppose that the
utility function of a consumer is given as U= f(X, Y)
Let us now suppose that the consumer substitutes X for Y, when the
consumer forgoes some units of Y, stock of Y decreases by ∆Y while X
increases by ∆X amount.
 Loss of utility from decrease in quantity of Y can be expressed as
- ∆X*MUy
 On the other hand, as a result of substitution, his stock of X
increased by ∆X, here gain of utility from increases quantity of X
by ∆X amount equals +∆X * MUX
[Also look; dU =(∂U /∂ X )dX +(∂ U /∂ Y )dy=0
Total change in utility = dU = 𝜟U, and dU = 0, because utility can’t
change on an IC
Total quantity change in good X = dX =ΔX
∂ U /∂ X =MUx is marginal utility from good X – indicates change in U per
unit of change in good X
Total quantity change in good Y = dY = 𝜟Y and
∂ U /∂ Y =MUy - Marginal utility of good Y
It indicates change in TU per unit of change in good Y.

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Since the total utility remains the same on an IC; ⎹−∆ YMU Y ⎸ must be
equal to ∆ XMU X , i.e.,

¿−∆ YMU Y /¿ ∆ XMU X∨ ( ∂∂ UX ) dX=⎹−( ∂U

∂Y )
dY ⎸

−ΔY MUX
=
ΔX MUY
ΔY
 Here ΔX , - ratio of quantity changes is simply the slope of

indifference curve which gives the MRSY,X when X is substituted

for Y;
 MUX / MUY - ratio of the marginal utility from the two commodities
is thus equal to the MRS between goods X and Y; to slope of IC .

Symbolically, MRSY, X = marginal rate of substitution of X for y

−ΔY MUX
=
MRSYX = ΔX MUY
The MRS of X for Y represent amount of Y the consumer has given up
so as getting additional quantity of X.
 Slope of indifference curve is negative implying possibility of
substitution between commodities in consumption (X and Y). However,
substitution is carried out in a way that keeps total utility constant or
leaves total utility unaffected.
 The shape of IC is convex to origin – as we move along the X - axis
by increasing X and decreasing Y – the curve become flatter, its slope
fall in absolute term. This particular convex shape of IC (or fall in slope)
indicates the postulate or Law of DMRS.
 The Postulate of diminishing Marginal Rate of substitution is one of
the basic postulates of OUT or in indifference curve analysis, which
asserts marginal rate of substitution between commodities will
eventually tend to diminishes. This axiomatic assumption of ordinal
utility theory is analogous to the assumption of ‘Diminishing Marginal
utility’ in cardinal utility theory.

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Table 2.3 the Diminishing MRS between commodities X and Y (MRS Y,X)
Point on IC Y ∆Y X ∆X MRSY, X

= /- ∆Y/∆X/
A 12 - 1 - -
B 8 -4 2 1 4
C 5 -3 3 1 3
D 3 -2 4 1 2
E 2 -1 5 1 1

Y and X – denoted the quantities of commodity Y and X consumed,

respectively. from the table we can observe that , moving from
combination A through E MRS between X and Y decreases from 4 to 1
in absolute value ( see column 6).
ΔY change in good Y
MRS X,Y = ΔX change in good X
Indifference curves Map

Qy

- Indifference Map contain a set of ICs

- In the map, each IC represents
different
IC 3 level of utility
- The used to rank/order preferences
IC
or2satisfaction
- In the OUT, utility or preference is
IC 1
0 Qx
Indifference curves map
Indifference curves map - is a map containing a set or group of ICs
(indifference curves) that denote or show different levels of utility. On
indifference map the level of utility varies as we move from one IC to
the other. For-example, moving from IC 1 to IC3, on the indifference
map, the level of Utility increases. Utility denoted by IC 3 is higher than

17
utility represented by IC 1 because IC 3 is farther away from the origin
than IC1; and IC3 denoted larger quantities of both goods relative to
IC1.
U (IC 1 )> U (IC 2)>U (IC 3).
Single Indifference curve represent a constant level of utility even if
combinations of the two goods varies along IC, utility don’t change.
Map of Indifference curves contains more than two ICs representing
different level of utility.
Map of ICs used to rank or order level of utility. The far away an
IC from the origin it represents a higher level of utility.

Properties of indifference curves

1) An indifference curve has a negative slope, which denotes that if
the quantity of one commodity(Y) decreases, the quantity of the
other (X) must increase. That is, it shows the two goods are
substitute to each other.
2) The indifference curve is convex to the origin. This implies that the
slope of an indifference curve decrease as we more along the curve.
It is due to the Law of diminishing MRS X, Y. In addition to LDMRS, the
convexity of IC indicates the rate substitution between goods is
different for each point on the curve.
3) Indifference curves do not intersect. If they did, the point of their
intersection would imply two different levels of satisfaction on one
point, which is impossible. If intersect, it violet the assumption of
transitivity and consistency of choice, that is, ranking/order of utility
will become inconsistent.
4. The farther away from the origin an indifference curve lies, the
higher the level of utility it denotes; bundles of goods on a higher
indifference curve are preferred by the rational consumer. Because as
IC is far away from the origin, it represent large amount of quantity

18
consumed. This property is special relevant to indifference map which
used to rank /order utility from different bundles of goods consumed.
The budget constraint of the consumer
The consumer has a given income, which sets limits to his maximizing
behavior. Income acts as a constraint in the attempt for maximizing
utility. The income constraint, in the case of two commodities, may be
written; M = Px Qx + Py Qy
M – Denote the total budget/income, Px, P y are prices while Qy and Qx
denote quantities of the two goods. P x Q x– total expenditure on good X
& Py Qy - expenditure on good Y
We may present the income constraint graphically through the budget
line; whose equation is derived from the above income constraint
equation (by solving for QY);
M Px
Q y= − Q ; Equation of the budget line
Py Py x
If Q x =0, i.e. if the Consumer spends all of her/ his income on Y, she/he
M
can buy Q y = units of Y all the budget being spent on good Y.
Py
Similarly:
M Py
Q x= − Q If the consumer spends all his income on X,
Px Px y
M
i.e., at Q y =0 ; then Q x = : total quantity of X that can be
Px
purchased using all the budget.

QY
A M/PY

Budget Line
Slope = - Px/Py
B

19
 0 M/Px QX
Mathematically, the slope of the budget line is the derivative

[ ]
M M
−0
∆ Qy Py Py −Px
= = =
∆ Qx M −M / Px Py
0−
Py

The consumer in his attempt to maximize his satisfaction will try to

reach the highest possible indifference curve. But buying more and
more goods and obtaining more and more satisfaction he/she has to
work under two constraints;
I. Has limited money income ii. Prices for goods and services.
So how far he would go his purchase depends on the PC and MI.

2.2.2 Equilibrium of the consumer under ordinal / IC approach

Consumer attains her/his equilibrium when she/he eventually

maximizes total satisfaction (utility) given his income and market
prices of goods and services.
There are almost 3 conditions for consumer equilibrium
1. MRS must be equal to the ratio of commodity prices. Considering the
earlier two commodity model, we have;
MRSXY = MUX/MUY = P X / PY
(Slope of IC) = (Slope of the budget line)
2. The first condition (I) fulfilled when the highest possible IC is
tangent to the budget line.
3. At this point the budget constraint has to be maintained, ie, the
consumer has to exhaust its budget; M = X P x + Y P y
The equilibrium conditions depicted graphically below
Qy
*AB is budget line which is tangent to IC 2 at point E
A PX
* At point E, MRSX,Y = PY = MUX / MUY
equilibrium is at the point of tangency of IC 2 with
budget line.
20
 Y1 E IC 3
IC 2
IC 1
X1 B Qx

Exercise – suppose the following are given:

Total utility function: U = 2XY 2
∆U ∆U
Marginal utility functions: MU X ¿ = 2Y 2 & MU Y ¿ =
∆x ∆Y
4XY
PX = Birr 6, Py = 4 birr, M = Birr 180
A. writes the budget constraint equation (180 = 6X +4Y)
B. Determine the equilibrium quantity of X and Y in consumption and
show on graph

Solutions
Soln B: - equilibrium condition: MUx / MUy=Px/ Py
2
2Y 6
= Px /Py =
4 XY 4

⤇
Y 6
= 4 Y =12 X ; hence, Y =3 X
2X 4
180 = 6X + 4Y ⤇ 180 = 6X + 4(3X)
180 =18X ⤇ X = 180/18 = 10 Units
Since Y = 2X, Y = 3* 10 = 30Units
Thus; the equilibrium quantities are X = 10 & y = 30units
Y
45
IC
30 E

21
 0 10 18 X
Graphical presentation of the consumer
equilibrium

22