Consumer Equlibium

Chapter 3 Consumer Equilibrium
Introduction
How does a consumer determine the
amount of a commodity that should be consumed ?
Depends on:
Level of satisfaction derived Level of income
Constrains consumption
Basic Concepts
Utility is the satisfaction an individual
derives from the consumption of a particular commodity
Psychological phenomenon Marshall suggested - it can be measured Unit of measure - Utils
Basic Concepts
Utility
Total Utility (TU) Marginal Utility (MU)
Sum total of the

satisfaction derived when a given number of units of a commodity are consumed
Additional satisfaction
derived when one more unit of the commodity is consumed
Eg: the TU after 3 cups

of ice-cream is the sum of the satisfaction from the 1st, 2nd and 3rd cups
Eg: MU of the 3rd cup of

ice-cream is TU of 3 cups minus TU of 2 cups
Total Utility and Marginal Utility

Cups of Ice-cream (N) 1 2 3 4 5 6 Cups of ice-cream (N) 1 2 3 4 5 6 TU (utils) 18 34 46 51 51 43 TU= MU (utils) 18 18 + 16 = 34 34 + 12 = 46 46 + 5 = 51 51 + 0 = 51 51 - 8 = 43 MU (utils)= TU/ N 18 0 = 18 34 18 = 16 46 34 = 12 51 46 = 5 51 51 = 0 43 51 = -8 MU (utils) 18 16 12 5 0 -8
60
Total Utility Curve

Number of Cups 0 1 2 3 4 5 6 TU 0 18 34 46 51 51 43
50
40
Total Utility
30
20
10
0 0 1 2 3 4 5 6
Number of units consumed
Total Utility Curve

60 50
TU
40
Total Utility
30
20
10
0 0 1 2 3 4 5 6
Relationship between TU & MU

60 50 40
Total Utility
TU
30
20
10
0 0 1 2 3 4 5 6
Marginal Utility 0
MU
No. of units consumed

60 50 40
Total Utility
TU
30
20
10
0 0 1 2 3 4 5 6
Marginal Utility
MU

60 50 40
Total Utility
TU
30
When MU is decreasing
and positive, TU increases at a decreasing rate
20
10
0 0 1 2 3 4 5 6
When MU=0, TU is at
its maximum point
When MU is decreasing
Marginal Utility
and is negative, TU starts declining
MU
Law of Diminishing Marginal Utility

Statement of Law:
As more and more units of a commodity are consumed, the level of satisfaction derived from every additional unit of the commodity eventually declines
Implies that MU could increase initially, but

will eventually decline
Law highlights the behaviour of MU with units of

the commodity consumed
Assumptions
Utility is measurable - Utils Consumption takes place continuously over a
stipulated time period
Reasonable amount of the commodity forms a

unit
A grain of rice is NOT a reasonable amount
Consumers are rational

Marginal utility of money is held constant
Consumer Equilibrium - Single Commodity

Equilibrium is state of balance
No reason to deviate from equilibrium

At equilibrium, consumers satisfaction is maximum,
subject to budget constraint
Conditions for consumer equilibrium:

Net benefit is maximised
Net benefit is the difference between the TU in money terms and the expenditure made on consumption
MU in money terms is equal to the price of the commodity

Condition for Consumer Equilibrium:
Net benefit is maximized

Difference between the total utility in money terms and
expenditure is maximized
Assumptions:
Marginal utility of the Rupee is equal to 1 Price per cup of ice cream is : Rs 12

Total utility and expenditure on the consumption of ice creams
Units Total utility TU in money Total expenditure Difference consumed (in utils) terms (TU/MUR) (pxq) (in Rs) (net benefit) (in Rs)
18
18
12

18
18
12
34
34
24
10

18
18
12
2
3
34
46
34
46
24
36
10
10

18
18
12
2
3 4
34
46 51
34
46 51
24
36 48
10
10 3

18
18
12
2
3 4 5
34
46 51 51
34
46 51 51
24
36 48 60
10
10 3 -9

18
18
12
2
3 4 5 6
34
46 51 51 43
34
46 51 51 43
24
36 48 60 72
10
10 3 -9 -29

1 18 18 12 6
2
3 4 5 6
34
46 51 51 43
34
46 51 51 43
24
36 48 60 72
10
10 3 -9 -29

General Principle:
MU of commodity
MU of rupee MUx MUR = Px = Price of commodity
MUX MUR
is marginal utility of commodity x in money terms
Where: MUX is the marginal utility of commodity x MUR is the marginal utility of rupee PX is the price of commodity x

General Principle:
MU of commodity MU of rupee MUx MUR = Price of commodity
= Px
Marginal Utility / Price
Px
0 Units of the commodity
MUx

General Principle:
= Px
Px
Q Units of the commodity
MUx

General Principle:
= Px
E B
Px
AQ: Marginal Utility

BQ: Marginal Expenditure
Q Q Units of the commodity
MUx

General Principle:
= Px
Marginal Net Benefit
E B
Px

MUx

General Principle:
= Px
Marginal Net Benefit
E B
Px

MUx

General Principle:
= Px
E B
Px
DQ: Marginal Utility

CQ: Marginal Expenditure
Q Q Q Units of the commodity
MUx

General Principle:
= Px
Marginal Net Loss
E B
Px

MUx

General Principle:
= Px
Marginal Net Loss
E B
Px

MUx

General Principle:
= Px
Point of Equilibrium
E B
Px
MUx

Assumptions: MU of rupee is 3 and Price per ice cream is Rs 4 Total utility and expenditure on the consumption of ice creams
Units consumed Total utility (in utils) TU in money terms (TU/MUR) Total expenditure (pxq) (in Rs) Difference (net benefit)
15

15
34
11.3
3.3

15
2
3
34
46
11.3
15.3
8
12
3.3
3.3

Assumptions: MU of rupee is 3 and Price per ice cream is Rs 4 Total utility and expenditure on the consumption of ice creams Units consumed 1 Total utility TU in money Total expenditure Difference (in utils) terms (TU/MUR) (pxq) (in Rs) (net benefit) 15 5 4 1
2
3 4
34
46 51
11.3
15.3 17
8
12 16
3.3
3.3 1

15
2
3 4
34
46 51
11.3
15.3 17
8
12 16
3.3
3.3 1
51
17
20
-3

15
2
3 4
34
46 51
11.3
15.3 17
8
12 16
3.3
3.3 1
5
6
51
43
17
14.3
20
24
-3
-9.7

Assumptions: MU of rupee is 3 and Price per ice cream is Rs 4 Total utility and expenditure on the consumption of ice creams Units consumed 1 Total utility TU in money Total expenditure Difference (in utils) terms (TU/MUR) (pxq) (in Rs) (net benefit) 15 5 4 1
2
3 4
34
46 51
11.3
15.3 17
8
12 16
3.3
3.3 1
5
6
51
43
17
14.3
20
24
-3
-9.7
Consumer Equilibrium - Two Commodities Case

Equilibrium condition for commodity x:
Mux MuR Mux Px = Px =MuR ------------------ (i)

Equilibrium condition for commodity y:

Muy MuR MuY PY = Py = MuR ------------------ (ii)

Equilibrium condition for commodity y:

Muy MuR = Py = MuR ------------------ (ii) MuY = MuR PY
(i) = (ii)
MuY PY
Mux = Px
Consumer Equilibrium - Two Commodity Case

Equilibrium conditions for 2 commodities
Ratio of the marginal utility to price of one

commodity is equal to the ratio of the marginal utility to the price of the second commodity
Mux = Px
MuY PY
Expenditure on both commodities should be

less than or equal to consumers income
Px . Qx + Py . Qy < Y

Shyama has Rs 10 to spend on oranges and apples. Price of each fruit is Rs 2 per kg. Using the marginal utility schedule given below determine the extent to which Shyama should consume each of the fruits to maximize her satisfaction.
Quantity in Kgs 1 2 3 4 5
MU of apples 16 14 12 10 8
MU of oranges 14 12 10 8 6

Quantity MU in Kgs of apples 1 2 3 4 16 14 12 10 MU of oranges 14 12 10 8 MU of apples/ price of apples 8 7 6 4 MU of oranges/ price of oranges 7 6 5 3

In the above table the ratios of marginal utilities to prices are equal for the following combinations of apples and oranges: 2 apples + 1 orange
3 apples + 2 oranges
4 apples + 3 oranges 5 apples + 4 oranges

The expenditure incurred on each of the above combinations is given in the table below: No. of No. of Price of Price of Expenditure Expenditure Total Apples oranges Apples Oranges on Apples on Oranges Expenditure (Rs) (Rs) (Rs) (Rs) (Rs) 2 3 4 5 1 2 3 4 2 2 2 2 2 2 2 2 4 6 8 10 2 4 6 8 6 10 14 18
Shyama chooses 3 kg of apples and 2 kg of oranges as she maximises utility, subject to her budget of Rs 10

Consumer Equlibium

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Chapter 3 Consumer Equilibrium

Sum total of the

Eg: the TU after 3 cups

Eg: MU of the 3rd cup of

Total Utility and Marginal Utility

Total Utility Curve

Number of units consumed

Total Utility Curve

Number of units consumed

Relationship between TU & MU

Number of units consumed

No. of units consumed

Relationship between TU & MU

Number of units consumed

No. of units consumed

Relationship between TU & MU

Number of units consumed

and is negative, TU starts declining

No. of units consumed

Law of Diminishing Marginal Utility

Implies that MU could increase initially, but

Law highlights the behaviour of MU with units of

Reasonable amount of the commodity forms a

Consumers are rational

Consumer Equilibrium - Single Commodity

No reason to deviate from equilibrium

Conditions for consumer equilibrium:

MU in money terms is equal to the price of the commodity

Consumer Equilibrium - Single Commodity

Net benefit is maximized

Consumer Equilibrium - Single Commodity

Consumer Equilibrium - Single Commodity

Consumer Equilibrium - Single Commodity

Consumer Equilibrium - Single Commodity

Consumer Equilibrium - Single Commodity

Consumer Equilibrium - Single Commodity

Consumer Equilibrium - Single Commodity

Consumer Equilibrium - Single Commodity

is marginal utility of commodity x in money terms

Consumer Equilibrium - Single Commodity

0 Units of the commodity

Consumer Equilibrium - Single Commodity

Q Units of the commodity

Consumer Equilibrium - Single Commodity

AQ: Marginal Utility

Q Q Units of the commodity

Consumer Equilibrium - Single Commodity

Marginal Net Benefit

AQ: Marginal Utility

Q Q Units of the commodity

Consumer Equilibrium - Single Commodity

Marginal Net Benefit

AQ: Marginal Utility

Q Q Units of the commodity

Consumer Equilibrium - Single Commodity

DQ: Marginal Utility

Q Q Q Units of the commodity

Consumer Equilibrium - Single Commodity

Marginal Net Loss

DQ: Marginal Utility

Q Q Q Units of the commodity

Consumer Equilibrium - Single Commodity

Marginal Net Loss

DQ: Marginal Utility