Consumers Equilibrium


Consumer’s Equilibrium:

Having explained indifference curves and budget line, we are in a position to explain how a consumer reaches equilibrium position. A consumer is in equilibrium when he is deriving maximum possible satisfaction from the goods and is in no position to rearrange his purchases of goods. We assume that :

(i)the consumer has a given indifference map which shows his scale of preferences for various combinations of two goods X and Y.

(ii)he has a fixed money income which he has to spend wholly on goods X and Y.

(iii)prices of goods X and Y are given and are fixed for him. To show which combination of two goods X and Y the consumer will buy to be in equilibrium we bring his indifference map and budget line together.

We know by now, that the indifference map depicts the consumer’s preference scale between various combinations of two goods and the budget line shows various

customers equilibrium ngp bcca 1st year

combinations which he can afford to buy with his given money income and prices of the two goods. Consider Figure 12, in which IC1, IC2, IC3, IC4 and IC5 are shown together with budget line PL for good X and good Y. Every combination on budget line PL costs the same. Thus combinations R, S, Q, T and H cost the same to the consumer. The consumer’s aim is to _aximize his satisfaction and for this he will try to reach highest indifference curve. But since there is a budget constraint he will be forced to remain on the given budget line, that is he will have to choose any combinations from among only those which lie on the given price line.

Which combination will he choose? Suppose he chooses R, but we see that R lies on a lower indifference curve IC1, when he can very well afford S, Q or T lying on higher indifference curve. Similar is the case for other combinations on IC1, like H. Again, suppose he chooses combination S (or T) lying on IC2.

But here again we see that the consumer can still reach a higher level of satisfaction remaining within his budget constraints i.e., he can afford to have combination Q lying on IC3 because it lies on his budget line. Now what if he chooses combination Q? We find that this is the best choice because this combination lies not only on his budget line but also puts him on highest possible indifference curve i.e., IC3 The consumer can very well wish to reach IC4 or IC5, but these indifference curves are beyond his reach given his money income.

Thus the consumer will be at equilibrium at point Q on IC3. What do we notice at point Q? We notice that at this point, his budget line PL is tangent to the indifference curve IC3. In this equilibrium position (at Q), the consumer will buy OM of X and ON of Y At the tangency point Q, the slopes of the price line PL and indifference curve IC3 are equal. The slope of the indifference curve shows the marginal rate of substitution of X for Y (MRSxy)






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