Consumer Equilibrium Micro Economics Notes

CONSUMER EQUILIBRIUM

Equilibrium means position of rest. Consumer equilibrium refers to the situation where consumer achieves position of rest. Whenever, consumer achieves the position of maximum satisfaction, he/she is said to be at equilibrium. This is the theme of this chapter and one should try to learn , how or when a consumer can achieve the maximum satisfaction level.

SUMMARY OF CHAPTER

1. What is consumer equilibrium – Meaning and analysis.
2. Approaches to study consumer equilibrium – Cardinal utility approach and ordinal utility approach.
3. Concept of Total Utility(TU), Marginal Utility(MU) and its calculation.
4. Law of Diminishing Marginal Utility.
5. Equilibrium condition under cardinal approach – Single Commodity and Double Commodity case.
6. Concept of Indifference Curve.
7. Monotonic Preferences.
8. MRS
9. Budget Line
10. Consumer equilibrium through ordinal approach.

There are two approaches to understand Consumer equilibrium. The first approach is called Cardinal Utility approach/ Marginal Utility analysis/Marshall’s Utility analysis. This approach was given by Alfred Marshall.

The second approach to study consumer equilibrium is ordinal utility approach/ Indifference curve analysis/Hicksian analysis. This approach was given by Hicks and Allen.

CARDINAL UTILITY APPROACH

Ques. What is Utility?

Ans. Utility is defined as the want satisfying power of a commodity.

Eg- A glass of water would have higher level of utility (want satisfactions) in summers than in winters. Reason is we need more water in summers as our body requires it more in summers than in winters. In short , same commodity may have higher or lower levels of satisfying power i.e. utility at different situations/ time. This also implies that utility is a subjective concept i.e. it will differ from person to person.

HOW TO MEASURE UTILITY

Under cardinal approach , utility can be measured in terms of cardinal numbers i.e. 1,2,3,4….This approach says that the level of satisfaction i.e. utility a person enjoys from the consumption of a particular good or service , can be measured in terms of numbers or cardinal numbers.

TOTAL UTILITY(TU)

Total Utility refers to total satisfaction obtained from the consumption of all possible units of a commodity.

 TU_n = ∑MU_n

MARGINAL UTILITY(MU)

Marginal Utility is the additional utility derived from the consumption of one more unit of the given commodity.

MU_n = TU_n -TU_n-1

MU=ΔTU/ΔQ

Where , Q= Quantity

MU= Marginal Utility

RELATIONSHIP BETWEEN TU AND MU 

1. TU increases as long as MU is positive
2. TU is at its’ maximum/Peak , when MU is zero.
3. TU falls when MU becomes negative.

Note – The point when MU becomes zero or when TU is maximum is known as the point of satiety or maximum satisfaction.

LAW OF DIMINISHING MARGINAL UTILITY

Law of Diminishing Marginal Utility states that as we go on consuming more and more units of a commodity , the utility derived from each additional unit declines.

This law is also known as fundamental laws of satisfaction or fundamental Psychological law.

ASSUMPTIONS OF LAW OF DIMINISHING MARGINAL UTILITY

1. Utility can be measured in terms of cardinal numbers. Eg- 1,2,3….etc.
2. Utility can be measured in monetary terms also.
3. Consumption is continuous.
4. Quality of all the successive units do not change.
5. Consumer is rational.
6. MU of money is constant.
7. Price of commodity remains fixed.