Consumer Equilibrium

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Consumer Equilibrium : –

Consumer Equilibrium refers to the situation, where a consumer, with limited income, achieves maximum satisfaction , without changing the manner of spending on existing expenditure.A consumer, who wants to consume a particular good, may have limited income. Such consumer has to pay a price for each unit of  commodity he purchases. Given the limited income, the consumer can only buy limited quantity of goods. We also know that as per the law of Diminishing Marginal Utility, the additional utility derived from each successive unit, keeps on decreasing. Due to these reason, every rational consumer , tries to achieve maximum satisfaction by incurring expenditure accordingly.

Consumer equilibrium can arise in the following two scenarios : –

  1. Consumer’s entire income is spent on single commodity.
  2. Consumer’s  income is spent on  two

Lets discuss these two in detail : –

Consumer’s equilibrium in case of single commodity : –

Where a consumer purchases a single commodity, the equilibrium is said to exist at the point where the quantity purchased by consumer gives him the maximum satisfaction, or in other words, when marginal utility of the commodity is equal to price paid for the commodity.

The number of units of a commodity , which a consumer would consume would depend on two factors :-

  1. Price of the given commodity
  2. Expected Marginal utility from each successive unit.

Marginal utility in money terms

MU of one extra unit of money (say rupee in India) is the additional utility obtained by  a consumer, when he spends an additional rupee on other goods.

Marginal utility in terms of money = \cfrac { Marginal\quad Utility\quad in\quad Utils }{ Marginal\quad Utility\quad of\quad one\quad rupee\quad (MUm) }

Equilibrium condition in case of single commodity :-

Consumer who consumes a single commodity (say x),  will be at equilibrium when Marginal utility of the commodity (MUx) is equal to price paid (Px) for the commodity.

  • Marginal utility of the commodity Mux > Price Paid (Px)

This means that the benefit obtained by consumer on additional unit purchase (Mux ) is greater than the price paid for commodity and consumer will keep buying additional units of goods. As consumer keeps buying additional units of goods, MU will fall due to the operation of the law of diminishing marginal utility. When Mu is  equal to price, the consumer gets maximum benefits , and is in a state of equilibrium.

 

  • Marginal utility of the commodity Mux < Price Paid (Px)

This means that the benefit obtained by consumer on additional unit purchase (Mux ) is less than the price paid for commodity . The consumer will keep reducing the consumption of commodity ‘x, until his   Marginal Utility is equal to price.

Consumer’s Equilibrium in case of Two commodities.

Where the consumer spends income on two commodities, he achieves maximum satisfaction when the following conditions are satisfied : –

  • MU of two commodities and their respective prices are equal –

For two given commodities x and y

\cfrac { \quad MUx }{ Px } \quad =\quad \cfrac { MUy }{ Py } \quad =\quad MUm

and

  • MU falls with an increase in consumption – If this condition is not satisfied, the consumer will keep buying only one good , which is unrealistic and consumer will never reach the equilibrium position.

This law is also know as the “Law of Equi-Marginal utility”.

For Example : –

Lets say the  total income of a consumer is Rs.20. He intends to purchase two commodities x and y, which are priced at Rs. 4 each per unit .

Consumer’s equilibrium in case of commodities  x and y is as under :-

Units ConsumedMux (“units”)MUy (“units”)
14032
22824
32416
41414
5106

 

From the above table, given that commodity ‘x’  has utility of 40 utils as against 32 utils of commodity y, consumer would spend first rupee on commodity x. Similarly, the second rupee will be spent on commodity ‘y’ to get utility of 32 utils, as utils of commodity x for second rupee is 28. The consumer would reach equilibrium when : –

  • MU of last rupee spent on each commodity is same – 4 units consumed
  • MU falls as consumption increases
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