Consumers equilibrium

Consumers equilibriumBy Dr Naheed SultanaUtility.The power of a product to satisfy human wants is called utilityThe value a consumer places on a unit of a good or service depends on the pleasure or satisfaction he or she expects to derive form having or consuming itTotal Utility: The aggregate level of satisfaction or fulfillment that a consumer receives through the consumption of a specific good or service, it is sum of marginal utilitiesMarginal Utility: Marginal utility is the utility a consumer derives from the last unit of a consumer good he or she consumes Rational consumerConsumers are utility maximizersConsumers prefer more of a good to less of it. A consumer would either prefer X to Y or Y to X, or would be indifferent between them. Transitivity: If a consumer prefers X to Y and Y to Z, then X is preferred to ZAssumption of cardinal approach to utility or utility is measured in terms of Utils

Law of diminishing MUThe "Law of Diminishing Marginal Utility" states that for any good or service, the marginal utility of that good or service decreases as the quantity of the good increases, ceteris paribus. In other words, total utility increases more and more slowly as the quantity consumed increases.QTUMU00014545285403120354140205150106157771603816009155-5Consumers equilibriumNo of unitsMU IMU B145602405533550420305101567573080-59-5-10Suppose consumer is consuming two products ice cream and burger. The price of Ice cream is Rs.20 and price of burger is Rs. 30Suppose utility of one rupee is 2 utilsConsumer will consume two units of Ice cream and one unit of burgerIf price of Ice cream reduces to Rs.10 and of Burger to Rs 25 the consumer will increase the consumption of Ice cream to 4 units and of burger to 3 units The rational spending ruleSpending should be allocated across goods so that the marginal utility per rupee is same for each good orMua/Pa =Mub/PbAs we have seen that reduction in price increases consumption, so we can derive law of demand with the help of consumers equilibriumOrdinal approach of consumers equilibriumAccording to Slutsky and Hicks we cant measure utility in terms of UtilsWe can only arrange utility of different consumption bundles in terms of preferencesA > B or B>A

Indifference schedule

The indifference curve

Indifference curve

Marginal Rate of Substitution

Marginal rate of SubstitutionCombinationsApplesMangoesMRS1151-21124:13833:14642:15551:1Law of Diminishing MRSAS more and more of one good is consumed along an indifference curve, the consumer is willing to give up less and less of some other good to maintain the satisfaction level

Indifference MapXYU1U2U3U4OSlope = Change in Y/Change in X= MUx/MUyIndifference Map

Properties of Indifference curves Indifference curves for two goods are generally negatively slopedThe slope of an indifference curve reflects the degree of substitutability of two goods for one anotherIndifference curves are generally convex, reflecting the principle of diminishing returnsIndifference curves never crossIndifference curves that are farther from the origin represent higher levels of utilityIndifference curves for a good and a bad are positively sloped

Budget LineA consumers budget line shows the combination of goods that can be purchased with a given money income and prices of goods held constantSuppose consumer is purchasing X and Y with income I, budget constraint isI=PxX + PyY or 10X +5Y= 100 thenX is 10 when Y is 0 and Y is 20 when X is 0Budget LineXYOIncome = Px .Qx + Py. QyI/PyI/PxSlope = Px/PyShifting of B.LWhenever there is increase in income consumer can purchase more of both goods therefore budget line shifts to the right

Change in Price of XWhen price of X decreases consumer can buy more of X in given income so X intercept increases and there is change in slope of budget line

Assumptions of equilibrium

Consumers equilibrium

In the diagram there are 4 IC curves representing utility of U1, U2, U3 and U4. the consumer can not achieve U4 as it is out of budget line. Consumer must be at the budget line.At point a utility level is U1 if consumer changes the combination and increases the consumption of X utility increases to U2 . The consumers satisfaction is maximum at point c where budget line is tangent to IC or slope of IC= slope of BLSlope of IC:U=f (X,Y)----U=U/ X* dX + U/ y*dy=0Or Mux*dX + Muy*dy =0Mux*dX= -Muy*dydY/dX = - MuX/Muy = MRSSlope of BLPxX+PyY=I, Y= I/Py Px/Py*XdY/dX = -Px/PyIn equilibrium the slope of IC is equal to slope of BL so we can right equation of consumers equilibrium as followsMuX/MuY= -Px/PyMRS= - Px/Py

A change in the price of X: Income and substitution effectsXYU1U2U3U4OabcdeU5C Xo X1YoY1cA change in the price of X: Income and substitution effectsXYU1U2U3U4OabcdeU5C Xo X1YoY1c