consumer equilibrium

Consumer Equilibrium using Cardinal Approach

Consumer equilibrium is the situation where a consumer gets maximum utility/satisfaction at prevailing prices in the market.

Following is the consumer equilibrium using cardinal utility approach which means the consumer can measure his/her satisfaction in numbers. Cardinal utility approach divides consumer equilibrium in 2 cases:

  • One commodity case
  • Two commodity case

One Commodity Case(Consumer Equilibrium)

Assumptions

  • The utility is cardinal i.e. it can be measured numerically
  • Price of good is constant
  • The income of the consumer is constant
  • The consumer will buy one good only
Quantity Price (Rs.) Marginal Utility (MU) Total Utility (TU)
1 5 10 10
2 5 8 18
3 5 7 13
4 5 5 17
5 5 3 20
  • A rational consumer makes his/her choice of buying goods which give him/her maximum utility by comparing Marginal Utility (MU) and Price (P) of the commodity/good. From the above table, we can see that at 4th unit MU = P which is the point where the consumer is at equilibrium.
  • 1 unit above 4th unit i.e. 3rd unit, here MU > P which means the consumer can buy more unit of a good which will give him additional utility.
  • 1 unit below 4th unit i.e. 5th unit, here MU < P which discourages the consumer to buy more unit of the good as it utility derived at the 5th unit is less than the price. Therefore, Consumer equilibrium is at 4th unit where MU = P = 5 and TU = 17.

For all this Law of Diminishing Marginal Opportunity (LDMU) must operate which says when more and more units of a good are consumed the utility derived from every additional unit goes on decreasing.

Two Commodity Case

Assumptions

  • Utility is cardinal i.e. it can be measured numerically
  • Price of both the goods is constant
  • Income of consumer is constant
  • Consumer spend entire income on both the goods

For a consumer to be in equilibrium in two commodity case MUx/Px = MUy/Py i.e. Law of Equi-Marginal Utility should be achieved which means that utility derived from spending the last rupee on Good X is equal to the utility derived from spending the last rupee on Good Y.

Case 1 : MUx/Px > MUy/Py

If MUx/Px > MUy/Py , which means by spending the last rupee on Good X gives more utility than spending last rupee on Good Y. This induces the consumer to buy more of Good X than Good Y due to which utility derived from Good X goes on decreasing and utility derived from Good Y increases (because of the law of marginal diminishing utility ). Therefore, MUx/Px decreases while MUy/Py increases as Px and Py are constant. This change will continue till the time MUx/Px = MUy/Py and Consumer Equilibrium is achieved.

Case 2 : MUx/Px < MUy/Py

If MUx/Px < MUy/Py , which means by spending the last rupee on Good Y gives more utility than spending last rupee on Good X. This induces the consumer to buy more of Good Y than Good X due to which utility derived from Good Y goes on decreasing and utility derived from Good X increases (because of the law of marginal diminishing utility ). Therefore, MUy/Py decreases while increases as Px and Py. This change will continue till the time MUx/Px = MUy/Py and Consumer Equilibrium is achieved.

For this Law of Diminishing Marginal Utility must operate. Example – If suppose LDMU (Law of Diminishing Marginal Utility) does not operate then, when Mux/Px > MUy/Py and consumer consumes more of Good X than Good Y which will always give him more utility From Good X than Good Y and consumer will end up spending his/her entire income on Good X only. And same goes when MUx/Px < MUy/Py, here consumer will end up spending his/her entire income on Good Y as it gives more utility than Good X. Therefore to attain Consumer Equilibrium Law of Diminishing Marginal Utility must operate.                                       

Abbreviations Used:

  • MUx – Marginal Utility from Good X
  • MUy – Marginal Utility from Good Y
  • Px – Price of Good X
  • Py – Price of Good Y

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