Consumer Equilibrium
A consumer is said to behave reached his equilibrium position when he has maximized the level of his satisfaction, given his resources and other condition. At equilibrium, the consumer is supposed:
a. To have spent his entire income on the goods and services he consumes.
b. To have attained the optimum allocation of resources on various goods and services he consumes.
c. To have achieved the optimum quality of each good and service.
Law of Diminishing Marginal Utility and Consumers Equilibrium
OR
One Commodity Model
The law states that when an individual consumer consumes more or more units of the commodity, the utility derived from each successive unit of the commodity goes on falling, but the total utility increase at a decreasing rate.
According to Marshall, “The additional benefit which a person derives from a given stock of a thing diminishes with every increase in the stocks that he already has.”
Let a consumer with the certain money income and commodity X. Since both his money income and commodity X have utility for him, he can either spend his money income on commodity X or retain it in the form of asset. If the marginal utility of commodity X, (i.e. MUx), is greater than the marginal utility of money (MUM) as an asset, a utility-maximizing consumer will change his money income of the commodity. Therefore, he reaches equilibrium (i.e. at the level of maximum satisfaction), where
MUx = Px(MUm) OR MU/P(MU)
E point is the equilibrium of the consumer where MUx = Px (MUm). This equilibrium indicates that he maximizes utility by consuming OQ units. At any points above E, MUx > Px(MUm). Therefore, if the consumer exchanges his money income for commodity X, he increases his satisfaction per unit commodity. At any point below E, MUx< Px(MUm), the consumer can, therefore, increase his satisfaction by reducing his purchase. It is proved that at any point other than E, a consumer gets satisfaction less than the maximum. Therefore, point E is the point of consumer’s equilibrium.
Law of Substitution and Consumer Equilibrium
OR
Two or Multiple Commodity Model
Law of substitution states that other things being equal, a consumer gets maximum total utility by spending his given income when he allocates his expenditure to the purchase of different goods in such a way that weighted marginal utility derived from the last unit of the money spent on each item of expenditure tends to be equal.
According to Marshall,”If a person has a thing which he can put to several uses, he will distribute it among these uses in such a way that he has same marginal utility, for it had a greater marginal utility in one use than in another, he would gain by taking away some of it from the second use and applying it to the first.”
This law is based on some proposition which is as follows:
a. Two or more goods are taken to be consumed in a given period of time.
b. The consumer who seeks to maximize his satisfaction must be rational.
c. The consumer has no control over the price of the commodity.
d. Wants are comparable, substitutable and complementary.
e. Goods are divisible and all units of the commodities are homogenous.
In the above figure, units of goods are measured on the X-axis and their marginal utility on the Y-axis. UU1 is the curve derived by the summation of the marginal utilities of apple and VV 1 is of oranges. The consumer is in an equilibrium situation when he consumes 4 units of apples(OF units) and 3 units of orange (OC units). In this situation, he has maximized his satisfaction because MUs of both goods and MU of money are equal, i.e. CD= FE= MUm. If he consumes one more unit of apple, his TU increased by the area EFGH but to gain this area, he has to decrease one more unit of orange, i.e. he has to lose the area ABCD which is greater than the area of gain EFGH, which is not beneficial to him. So he cannot choose the second content and the first one is the only one equilibrium condition. He has been maximizing the satisfaction or TUs by the given budget.
You may also like: Indifference Curve
Leave a Reply