Consumer’s Equilibrium

Who is consumer : - A consumer is one who buys goods and services for satisfaction of
wants. The objective of a consumer is to get maximum satisfaction from spending his income on
various goods and services, given prices.

Approaches that help you to understand consumer’s equilibrium:

❖ Utility approach
❖ Indifference curve approach

I. Consumer’s equilibrium with utility approach

❖ Utility :- Utility does not mean usefulness. The term utility refers to the want satisfying
power of a commodity. It means realised satisfaction to a consumer when he is willing
to spend money on a stock of commodity which has the capacity to satisfy his want.
Expected satisfaction is different from realised satisfaction. Realised satisfaction takes
place only after the commodity has been consumed. Expected satisfaction takes place
when the commodity has not been bought but the consumer is willing to buy it. A
commodity has utility for a consumer even when it is not consumed. Further, the same
commodity has different utility for different persons, and also to the same person at different
points of time.

❖ Total Utility (TU) :- It is the sum of all the utilities that a consumer derives from the
consumption of a certain amount of a commodity. Mathematically, TU can be obtained
by the sum of marginal utilities from the consumption of different units of the commodity.
TUn = MU1 + MU2 + .....+ MUn

❖ Marginal Utility (MU) :- It is addition made to the total utility as consumption is

increased by one more unit of the commodity. Mathematically, it is calculated as:

MUn = TUn – TUn – 1

∆𝑇𝑈
Or MU = ∆𝑋

❖ Relationship between Total and Marginal Utility

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1. As the consumer has more of the good, the TU increases less than in proportion and the MU
gradually declines but is positive.
2. When TU is maximum, called saturation point, MU is zero.
3. When TU falls, MU becomes negative.
4. If consumer is rational, he will stop at 8 units. This is because if he consumes more than 8 units,
then TU will decline and MU will become negative (the good will give disutility).
5. If any one of the schedule is given, the other can be easily derived as: MUn = TUn – TUn – 1
and TUn is the sum of the MU till nth level i.e., TUn = MU1 + MU2 + .....+ MUn .

❖ Relationship between TU and MU Curves

(a)TU curve starts from the origin, increase at a decreasing rate, reaches
a maximum and then starts falling.
(b)MU curve is the slope of the TU curve, since MU = ∆TUX /∆QX
(c) When TU is maximum, MU is zero, it is calledsaturation point. (since
slope of TU curve at that point is zero). Units of the good are consumed
till the saturation point.
(d)As long as TU curve is concave, MU curve is downward sloping and
remains above the x-axis.
(e) When TU curve is falling, MU curve becomes negative.
(f )The falling MU curve shows the law of diminishing marginal utility.

❖ The Law of Diminishing Marginal Utility

The law states that as a consumer consumes more and more units of a commodity, marginal utility
derived from each successive unit goes on diminishing. A stage comes when marginal utility
becomes zero. At this point total utility becomes maximum. If the consumer consumes beyond this
stage, marginal utility becomes negative and total utility falls. It means that consumer starts getting
disutility i.e., dissatisfaction instead of getting satisfaction. Since, economists believe that a

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consumer is a rational being, he wants to maximize his satisfaction. A consumer would not like to
go beyond zero marginal utility.

The above table shows that as a consumer consumes first unit of apple, he gets 10 utils as
marginal utility. When he consumes 2nd unit he gets 8 utils as marginal utility and so on. This
proves that marginal utility declines continuously as the consumer consumes more and more units
of the same commodity.

❖ Assumptions of the Law of DMU

1. Standard unit of measurement is used. If the unit of measurement is very large or very small
then the law will not hold. Examples of inappropriate units are: rice measured in miligrams, water
in drops, diamonds in kilograms.
2. Homogeneous commodity. All units of the commodity consumed are homogeneous and
perfect substitutes.
3. Continuous consumption. The law of DMU holds only when consumption of successive units
of a commodity is without a time gap.
4. Mental and social condition of the consumer must be normal. The law will hold when
consumer’s mental condition is normal. His income and tastes are unchanged and his behaviour is
rational.

❖ Assumptions of the Utility Approach

1. Utility can be measured, i.e. can be expressed in exact units. Utility is measurable in monetary
terms.
2. Consumer’s income is given.
3. Prices of commodities are given and remain constant.
4. Constant Marginal Utility of Money. It means that importance of money remains unchanged.
Marginal utility of money is addition made to utility of the consumer as he spends one more unit of
the money income. This is assumed to be constant.

❖ Consumer’s Equilibrium:
A consumer is said to be in equilibrium when he maximizes his satisfaction, given income
and prices of the commodities. In economics, consumer is the one who takes decisions about
what to buy for satisfaction of wants. Consumer takes decision on the basis of his preferences, his
income and the prices of the commodities which are prevailing in the market.

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 1. One Commodity Case
Let us suppose that a consumer has a given income with which he consumes only one commodity
X. Since both his money income and commodity X have utility for him, he can either spend his
money income on commodity X or retain it with himself. If the consumer holds his income, the
marginal utility of commodity (MUX) becomes greater than marginal utility of money income (MUM).
In that case, total utility can be increased by exchanging money for good X. Thus, a consumer is in
equilibrium when he satisfies the following condition:

i.e., MU of the good = Price of the product

or MUX = PX
Consumer’s equilibrium in case of single commodity can be explained with the help of following
schedule. Given that utility is a cardinal concept, the MU from different units of a good X can be
measured in terms of money. Suppose price of good X is ₹ 5 per unit.

If PX = ₹5, then the consumerwill buy three units of good X. If the consumer buys less than 3 units
say 2 units then the MU he derives from 2 units is worth ₹6 and the price he pays is ₹5. Since his
MUX > PX', he buys more. In other words, since price is less, he buys more which is the logical
basis of the law of demand.
A consumer will not buy more than 3 units of X. This is because if he buys 4 units of X then the
price he pays (₹5) will be more than the MU he derives which is worth ` 4. Hence, in order to
maximise utility a consumer will buy that quantity of the good where the MU of the good is equal to
the price that he has to pay.
Therefore, a consumer is in equilibrium when he consumes three units of good X because at three
units of good X, MU of good = Price of the product. The consumer’s equilibrium condition is
geometrically at point E.
where MUX = PX. The equilibrium price is given at OP. The consumer will buy OQ quantity of X in
order to maximise his utility. Total gain falls if more is purchased after equilibrium.

2. Two Commodities Case–Law of Equi-Marginal Utility

Let us now analyse a two commodity case. We assume that a consumer consumes only two
commodities X and Y and their prices are PX and PY respectively. In such a case, the law of DMU
is extended to two goods which the consumer buys with his income. The condition required by a
consumer to maximise his utility for two

commodities X and Y is given as:

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 MUx= PX ... (1)

MUY= PY ... (2)

Divide equation (1) by (2), we get:

𝑀𝑈𝑋 𝑀𝑈𝑌
𝑃𝑋
= 𝑃𝑌

This is called the law of equi-marginal utility. The law states that a consumer will so allocate
his expenditure so that the utility gained from the last rupee spent on each commodity is
equal.

In other words, a consumer buys each commodity up to the point at which MU per rupee spent on
it is the same as the MU of a rupee spent on another good. When this condition is met, a
consumer cannot shift a rupee of expenditure from one commodity to another and increase his
utility. Consumer’s equilibrium conditions in case of two goods X and Y can be written as:
𝑀𝑈𝑋 𝑀𝑈𝑌
𝑃𝑋
= 𝑃𝑌

It is subject to budget constraint that PX . X + PY . Y = M

𝑀𝑈𝑋 𝑀𝑈𝑌
When 𝑃𝑋
= 𝑃𝑌
, utility is maximum.

Example. When a person has a certain quantity of a commodity (say, so many gallons of water
per day)

which can be put to many different uses, say washing, bathing and cooking), he will, in order to get
the

maximum benefit from the use of it, so distribute it as between the different uses so that the MU
from the commodity is the same in all its uses. In short, same in all its uses. The law of Equi-MU is
shown graphically

where, OO1 = Total income of the consumer which is to be spent on two goods X and Y.

MUX = MU curve for good X as the successive

rupees are spent on X.
𝑀𝑈𝑋
Also, 𝑃𝑋
values can be obtained as PX is

given and fixed.

MUY = MU curve for good Y as the successive

rupees are spent on Y.

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 𝑀𝑈𝑌
Also, 𝑃𝑌
values can be obtained as PY is given and fixed.

E = Point of consumer’s equilibrium where the law of Equi-marginal utility holds

𝑀𝑈𝑋 𝑀𝑈𝑌
i.e. 𝑃𝑋
= 𝑃𝑌
. It shows that OM amount of income is spent on good X

and O1M on good Y. The consumer’s total utility at point E = OR1ES1O1.

𝑀𝑈𝑋 𝑀𝑈𝑌
What happens when 𝑃𝑋
is not equal to 𝑃𝑌
? Two disequilibrium situations are :

𝑀𝑈𝑋 𝑀𝑈𝑌
1) 𝑃𝑋
> 𝑃𝑌
: In this case, the consumer is getting more marginal utility per rupee in case of
good X as compared to Y. Therefore, he will buy more of X and less of Y. This will lead to fall in
𝑀𝑈𝑋 𝑀𝑈𝑌
MUX and rise in MUY. The consumer will continue to buy more units of X till 𝑃𝑋
= 𝑃𝑌
.

𝑀𝑈𝑋 𝑀𝑈𝑌
2) 𝑃𝑋
< 𝑃𝑌
: The consumer is getting more marginal utility per rupee in case of good Y as
compared to X. Therefore, he will buy more of Y and less of X. This will lead fall in MU Y and
𝑀𝑈𝑋 𝑀𝑈𝑌
rise in MUX. The consumer will continue to buy more of Y till 𝑃𝑋
= 𝑃𝑌
.

Prepared by :- Raja Shah

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