Category: Commerce Notes PPT

Entrepreneurship refers to the ability to develop and organise a business enterprise. It involves running a business for earning profit. An entrepreneur is a decision-maker person who establishes and administers a startup along with the risks and uncertainties entitled to it. Business management refers to the process of managing the administration of a business organisation. A manager is responsible for overseeing the business operations and reviewing the contracts. He helps the employees in working towards the fulfilment of the organisation’s goals and objectives. More often, the term entrepreneurship and small business management are misunderstood as one. However, there is a difference between these two.

Entrepreneurship can be defined as the desire and ability to establish and administer a startup venture. It involves the will to succeed in the venture and make profits. Generally, an entrepreneur earns profits by combining land, labour, natural resources and capital. 

Who is an Entrepreneur?

An entrepreneur is a person who is willing to take risks to earn profits. He must be a person with great imaginative power, orderliness and professionalism. He must be dedicated and opinionated. 

What is Management?

The management of a business is its foundation which organises and structures its entire ecosystem. Management refers to the overall functioning of the business. It involves planning and creating, managing and governing. It is an executive function which helps in the utilisation of all the resources of a company. 

The number of managers in a company depends upon the size of its management. Generally, the manager of a business is responsible for getting all the jobs done. He directly helps the company in achieving its goals and objectives. 

Difference Between Business Management and Entrepreneurship

Business management and entrepreneurship play a very important role in its success. However, these two are different from each other. The following are the main points of difference between management and entrepreneurship in business:

Meaning

Entrepreneurship is the process of building and creating an enterprise. It involves taking a financial risk to earn profits. An entrepreneur is the owner of the organisation and is directly affected by its working.

Management is a business activity. It involves getting jobs done by other workers in the organisation. A manager is responsible for managing all the business activities.

Function

Business management entrepreneurship involves deciding the production policy of the business organisation. An entrepreneur takes all the decisions such as what is to be produced and in what quantity, the place of production etc. 

The management in a company is responsible for the following activities- planning, organising, controlling and leading. A manager looks after an ongoing venture in the company. He allocates the employee resources and delegates responsibilities between them.

Status 

The status of an entrepreneur is of the owner of the business organisation. He is responsible for its working and success.

The manager is an employee of the organisation. He is hired by the entrepreneur and is given a monthly salary.

Rewards

An entrepreneur is the owner of the organisation earns from its profits and has to bear the losses. He does not earn a specified fixed amount every month.

A manager is a paid employee of an organisation. He gets a fixed salary to carry out his job. His reward is not affected by the profits or losses of the company.

Goals and Objectives

Its owner or entrepreneur sets the goals and objectives of an organisation. The concerned body is responsible for deciding the policies of the company. The job of a manager is to imply the goals and objectives set by the entrepreneur. He cannot decide the objectives or alter any policies on his own.

Decision Making

The decisions made by an entrepreneur are based on his gut feelings and personal perception. He is free to make any decision on his own without considering the advice of others. 

A manager has to make decisions after collecting all the information in detail. He has to analyse every factor before concluding. He has to consider the company’s objectives and policies before making any decision. 

Innovation

An entrepreneur is an innovator. He is responsible for bringing creative and innovative ideas into the business. A manager is an executor. His only responsibility is to execute the ideas and decisions made by entrepreneurial management.

Fraud

An entrepreneur is the owner of the business. He can never get involved in any fraud in the organisation.

A manager is a paid employee of the organisation. He can be involved in fraudulent behaviour or cheating by not giving his best or working inefficiently.

This article highlights the major difference between entrepreneurship and management. Both entrepreneurship & small business management play an important role in the success of a business organisation.

A cash book can be defined as a financial journal which contains all the cash receipts and disbursements. Cash Book also includes bank deposits and bank withdrawals. The entries that come in the cash book are then posted into the general ledger.

In the cash book entries, the daily cash receipts and cash payments are easily and smoothly analysed. The Cash in hand at any point of time can be easily ascertained through the Cash Book balance. Also, any mistake in the book can be easily detected at the time of verification of the cash. Any defalcation of money from the business can even be detected while verifying cash book.

Working of the Cash Book

A cash book is said to be a set up of the subsidiary to the general ledger, where all the cash transactions are made during an accounting period. The cash recordings are recorded in a chronological manner. Larger business concerns generally divide the cash book into two parts.  

The cash disbursements journal – Cash Disbursement Journal records all the cash payments and the cash receipts journal, which helps in recording the cash received into the business. The cash disbursement journal consists of such items as payments payable to vendors, which is done to reduce the accounts payable. The cash receipts journal consists of the payments that are made by the customers on the outstanding accounts receivable or the cash sales.  

The prior goal of a cash book is to manage the cash efficiently, it is easy to determine the cash balances at any point which will allow the managers and the company accountants to budget the business’s cash effectively when the need comes. This is much faster to access the cash information in a cash book than by following the cash through a ledger. 

Types of Cash Book

A cash book is both a ledger and also a journal. The book is for all the cash transactions required for a company since this performs the function of both the ledger and journal. The cash book records all the cash receipts on the debit side and all the cash payments of the company on the credit side. To know the four main kinds of cash book which a company may maintain, we need to delve deeper in its types:

1. Simple Cash Books- This is also known as the Single Column Cash Book. This cash book will only be recorded for the purpose of cash transactions. The cash that is coming in is known as the receipts which will be on the left and the cash payments are recorded on the right. As all the cash transactions are recorded here, there is no need for an extra ledger account.

2. Two Column Cash- BooksHere we have an additional column for the discounts. Thus, along with the cash transactions, we are also required to have discounts in the same cash book. Hence both the discounts received and the discount which is given here is recorded. The organizations who are in a general practice of giving or receiving the discounts, this type of cash book is the preferable option.

3. Three Column Cash- BooksThis cash book has three columns, consisting of the – cash, the discount and the additional column as the bank columns in it. With the development of banking most of the firms, these days prefer to deal in cheques or with the bills of exchange. Thus, having a bank column in the same cash book makes things concise and simpler to record and function. 

4. Petty Cash Book- The firm usually has cash transactions which are happening in all the departments. The cash transactions are then recorded in one of the above formats of the cash books. But there are a lot of cash transactions which are recorded for every small amount. Even the dozens of such transactions that occur in just one day are also recorded here. These are known as the petty transactions. 

More about Cash Book

It is defined as a financial book of records in which cash receipts, disbursements, are recorded. It also includes the record of bank deposits and withdrawals. The entries made in the cash book are posted into the ledger account. The concept of cash book is taught in class 11, in the accounts stream in chapter 4 called recording of transactions. This chapter is extremely important as after reading this chapter in-depth and referring to ‘s notes on cash book, students will be able to know what is the need for special purpose books, they will learn to record transactions in the cash book and how to post them in the ledger, they will learn what is a petty cash book and how to prepare a petty cash book, they will be able to record the transactions in the special-purpose book, they will be able to post entries in the special-purpose book as well as in the ledger, also they will learn the most important part of accounting that is how to balance the ledger accounts.

The balance in the cash book is updated and verified continuously and it is recorded in chronological order.

Large industries and firms divide the cash book into two parts in order to make accounting much easier and efficient, the two parts that the cash book is divided into are– the cash disbursement journal and the cash receipts journal.

There is a difference between a cash book and a cash account, a cash book is a separate ledger in which all the cash transactions are recorded, while a cash account is an account within a general ledger.

Cash books are of three types – single column, double column, triple column.

The cash disbursement journal includes items such as payments that are made to vendors in order to reduce accounts payable, a cash receipts journal includes items such as payments that are made by customers on accounts receivable or cash sales.

Cash books are updated continuously. This is done in order to manage cash efficiently which makes it easier to determine cash balances at any point whenever necessary. This allows the company heads or the company accountants to keep a systematic record to budget their cash.

Cashbook is an easier way to retain information about budget cash rather than by the following cash through a ledger.

Key Elements Whose Knowledge is Needed to get a Comprehensive Understanding of Cash Book:

In any business, communication is the key to express thoughts, ideas, facts, and plans. The means and ways of communication vary from person to person and depend on the situation. Business communication is best explained as the information sharing processes that lead to profit for any business. Business communication can take place between people within the organization or outside the organization. The characteristics of good business writing and the features of business communication are discussed here, in detail. 

What is Business Communication?

Any communication related to business is referred to as business communication. Communication, in general, refers to the sharing of thoughts and ideas between two or more individuals. All those communications that lead to the benefits for one or both the business partners are called business communication.

Business communication encompasses communication linked to administration, law, trade, finance, management, etc. Business communication is targeted towards the goal of any business firm. The communication occurs continuously between the two parties and is two-way in nature. Certain features of business communication make it clear and fruitful.

Features of Business Communication

There are six basic elements of any business communication and they are as follows. 

• Message- The message is the information that is needed to be exchanged between the parties.

• Sender- The person who is conveying the message to other parties is called the sender. It can be a single person or a group of people.

• Receiver- The person or parties who are receiving the messages from the sender.

• Channel- Every sender uses a medium to transfer the message to the receiver. The medium used to transmit the message is called the channel. It can be done over the letter, telephone, emails, fax, in-person conferences, or video conferences. 

• Symbols- In order to make the message concise and clear, the sender might use certain words, signs, and actions to express the emotions. These elements of the message are called symbols.

• Feedback- After receiving the message from the sender, the receiver responds in the form of feedback. This is the final element of any business communication.

All these basic elements also constitute the characteristics of written communication.

Objectives of Business Communication

The next question is, why business writings are being used. The objectives of business communication are listed below.

• A holistic approach to organizational development. 

• To elicit mutual relationships between the employees or collaborators of an organization.

• Conducting training programs for new and existing employees.

• Developing plans to attain the goals of the company.

• Providing necessary information for the proper execution of the plans.

• Providing support to the employees.

• Encouraging and supporting others in their action.

• Portraying any decision.

• Building trust.

• Conveying warnings.

• Calling for participation in problem-solving.

 

Characteristics of Business Communication

There are certain basic concepts for effective business writing. The characteristics of business communication that will help you to understand these concepts are given below.

• Realistic communication must be maintained.

• Imaginary information must be avoided at all costs.

• The communications must be targeted to a common goal. Any doubts in these communications must be taken care of.

• The business communications must be so formulated that it targets dedicated customers.

• Polite language must be used. It should not attack customers.

• The communication must not reflect any personal opinion. The use of metaphors and imagery must be avoided.

• The communication must depict real facts and figures. It should consider mutual understanding as to the base.

• It must follow the general characteristics of business reports.

• The basic concepts in effective business writings can be used to appreciate or warn against any specific activity. It can also be used to provide advice, instructions, information, suggestion, or support.

What are the Steps for Effective Business Communication?

In order to make your business communication approaches effective, it is important to follow the general characteristics of written communication. These characteristics are listed below.

• Do away with any form of assumptions. Consider facts, figures, and real-world items in your communication.

• Develop a good habit of listening. Listen carefully about the topic and then speak out your ideas.

• Ask important questions that can contribute to the cause.

• Consider both verbal and nonverbal communication with equal importance.

• Show your patience during any communication.

• Conduct any business conversation at an appropriate place and time.

• Maintain a proper decorum with all employees at a company. Have elevated levels of politeness for seniors and employees at higher ranks.

With the introduction of liberalisation in the global market during the year 1985 to 1990, the Indian government introduced several short term debt instruments. One such debt tool is the commercial paper that came into the Indian money market in 1990 and initiated financial reform in India. 

To put it simply, it is a short-term debt instrument availed by companies when they need immediate funds to meet their short-term liabilities. These liabilities can be anything from stocking up inventories to financing payroll or others. 

According to the Commercial paper definition, this unsecured promissory note comes along with a set maturity and is issued by All India Financial Institutions (FIs) and Primary Dealers (PDs). In India, this period is between 15 days to 364 days. 

To understand the concept of CP easily, consider this example. A firm named ABC requires funds to stock up inventory for the upcoming sale season. To do so, they have a deficit of ＄20 Million. In such a case, they can buy commercial paper from the issuers for a face value of say ＄20.1 Million (depending upon prevailing interest rate) and receive＄20 Million cash. So, the ABC Company pays an interest amount of ＄0.1 Million for the deal.

Commercial Paper Market in India

With CP as a debt instrument, the commercial paper market has become a component of the Indian money market. Here, the balance between supply and demand is met by two sections of people – 

These two promotes the market and help companies accumulate funds for their short-term financial liabilities or obligations at times of financial crisis. 

Types of Commercial Paper 

These can be broadly categorised into two parts depending upon the security it offers. 

• Secured Commercial Papers – These are often known as Asset-backed commercial papers (ABCP) wherein it is backed by physical assets like trade receivables, etc. 

• Unsecured Commercial Papers – In this unsecured kind, the paper isn’t backed by pledging any asset and is allotted without any security. 

Subsequently, the Uniform Commercial Code (UCC) has divided the commercial paper in India into four categories, as mentioned below. 

1. Draft – It is written by one individual to another (usually banks) asking to pay a definite sum to the third party. A drawer, drawee, and acceptor are involved in the process. It can be of two kinds – sight draft and time draft. 

2. Note – Also known as a promissory note, these are written by specifying the amount to be paid after a certain amount of time. Here two parties are involved – promisor (maker) and promisee (payee). 

3. Cheque – Like drafts, these are written in paper forms where the drawee is a bank.  

4. Certificates of Deposit – Often known as CD, this is an acknowledgement form issued by the bank confirming receipt of the deposit. Some of the difference between commercial paper and certificate of deposit is in terms of issuer, denomination, etc. 

Features of Commercial Paper 

• It is a short-term debt instrument tool that is set for a maturity period. 

• It is usually an unsecured debt where the company doesn’t pledge any asset but still qualifies for it based on their company’s liquidity, revenue-generating power, and achievements. 

• The commercial paper issuer guarantees or promises to pay the fixed amount to the subscriber in cash in future. 

• This paper can be used as a certificate of unsecured debt. 

Advantages and Disadvantages of Commercial Paper

Mentioned below are some pointers that discuss the merits and demerits of commercial paper. Have a look at these pointers to understand when it is beneficial to avail this paper. 

Merits 

• Since it is mostly unsecured in nature, your company’s assets aren’t on risk. 

• The method is a quick way to raise funds for working capital. It is a cost-effective method, as well as cheaper than bank loans. 

• The range of maturity varies, which makes it flexible. 

• Companies may save extra cash and convert them into good returns to save more through the process. 

• A customisable maturity range makes the process feasible for companies. Issuers can pay for the matured papers by selling new commercial paper. 

Demerits 

Even though the commercial paper has several advantages in the Indian market, there can be scenarios that make it inconvenient for certain companies. The amount for which a commercial paper is made is quite high, and since these are unsecured debt, only a few renowned blue-chip and profitable companies can subscribe to this. Besides, the credit available from a bank or financial institution may get reduced after issuing the paper. 

Despite a few limitations, this has helped bring financial reform in India and helped companies overcome the financial crisis. You can learn in detail about various such concepts included in the syllabus by visiting ’s website.

Commercial Papers used Today

Commercial papers do have a vital role in today’s world. In general, they are used to settle the debts that are short-term and also which are unsecured. If you don’t know it has been introduced to India only by 1990. So within the ten years lapse itself, the development it gave is really big.

So to increase the short-term borrowings the companies that are already having higher ratings will use commercial papers. Since they are using the bank and large corporations it is easier to get through the short-term obligations that are faced by newer projects. And in another way, we could say that by using commercial paper (CP) it is easier for any investor to get through the processing even faster. 

And the surprising fact is that the commercial paper does have a validity of maturity from a minimum of 7 days. And there is a maturity period of up to one year as well. The only thing we must take care of is that the period must not get over the credit rating date of the owner. So that is why the companies that are having a huge rating are given it. 

Auditing is the process of checking the financial statements along with other accounting information of a business entity. It is a systematic procedure where the economic condition of the entity is analyzed. The person taking up the responsibility of the process is called an “Auditor”.

In this process, it is checked if the business is running profitably or not. Auditing is an important process for the company, the investors, the government, creditors, shareholders, etc. They very much rely on audit reports to make important business decisions.

This is the concept of auditing in a nutshell.

Definition of Auditing:

An audit is when an auditor examines or inspects various books of accounts, followed by a physical inventory check, to ensure that all departments are using a defined system of recording transactions. It is done to ensure that the financial statements presented by the organisation are accurate.

Internal auditing can be done by employees or department heads, and external auditing can be done by a firm or an independent auditor. The goal is for an independent body to audit and verify the accounts to ensure that the books of accounts are completed fairly and that no misrepresentation or fraud is taking place.

Before they can announce their quarterly results, all publicly traded companies must have their accounts examined by an independent auditor.

What qualifications do you need to perform an audit? Any institution in India will have an independent audit conducted by chartered accountants from the Institute of Chartered Accountants of India or ICAI. Principles are set out by CPAs in the United States (Certified Public Accountants).

There seem to be four steps to the auditing process. The very first stage is to establish the auditor’s position and terms of engagement, which is typically done through with a letter signed by the client.

The second phase is to prepare the audit, which gave information like timelines and organizations that will be scrutinized by the auditor.

Is the auditor in charge of a particular division or the rest of the company? The audit could last a day or even a week, due to the nature of the audit.

When an auditor examines a company’s accounts or inspects its major financial statements, the results are usually published in a report or prepared methodically.

Analyzing the findings is the final and most important element of an audit. The conclusions of the auditor are detailed in the report.

Principles of Auditing

The basic principles of auditing are planning, honesty, secrecy, audit evidence, internal control system, skill and competence, work done by others, working papers, and legal frameworks.

Audit Report

Now we know what is meant by auditing. As discussed above, it is the inspection of financial statements of a business entity followed by checking inventory. Based on this investigation and assessment of the financial records, the auditor gives his opinion regarding the financial position of the organization in the form of a report.

It is ensured that the statements are prepared following the accounting standards, they comply with all statutory requirements and proper presentation of the records is done with all matters duly disclosed.

Advantages and Disadvantages of Auditing

Advantages of Auditing

• The major advantage of auditing is that It gives assurance to the owners, investors, etc. about the accuracy of their financial statements.

• During the auditing process, errors and frauds in the account books are discovered. In a way, it also prevents such errors for the fear of being detected.

• In the case of external audits, the books are very closely inspected, and the management gets a second opinion of their financial standing.

• Since the books are closely examined, it helps the employees to be honest and responsible while preparing the reports.

• The financial statements get more credibility while they are audited.

Disadvantages of Auditing

• Auditing involves a deep examination of records, which ends up in extra cost to the company.

• The reports of the audit act as evidence to make major changes in the accounts of the distribution of profits.

• The changes are calibrated and it makes the employees feel harassed

• Since the rules and regulations of business vary from time to time, it affects the result of the audit.

• Since the audit report is credentialed, there are chances for the companies to commit fraud and ultimately it will force the auditors to commit crimes after the audit.

• Smaller concerns do not consider auditing that important and proceed with regular transactions.

• The auditing report is prepared based on the information agreed by the clients and so it is not guaranteed.

Basic Principles Governing an Audit

This Auditing and Assurance Standard was the standard on auditing that was first issued by the Institute. It explains the basics of auditing that govern the professional responsibilities of an auditor.

The basic principles of auditing are confidentiality, integrity, objectivity, independence, skills and competence, work performed by others, documentation, planning, audit evidence, accounting system and internal control, and audit reporting.

1) A thorough examination of all systems

The assessment of all systems and procedures related to accounting and financial operations is the primary goal of any audit. Before beginning the audit of the final statements of accounts, the auditor must first comprehend the system and its functionality. It will serve as the foundation for the entire auditing process.

2) Internal Controls Assessment

The extent of the audit will be determined by the efficacy of the organization’s internal control system. The auditor can rely on the system if the company’s internal controls are in place and very effective. Then he won’t have to go over the accounting in great detail.

If the internal controls, on the other hand, are ineffective, the auditor must go over the accounts with a fine-tooth comb. The auditor must also assess the internal control system, according to CARO 2003.

3)Arithmetic Precision

The auditor must also check the accuracy of the books of accounts regularly. This includes double-checking the books’ arithmetical accuracy and verifying that the entries are properly posted.

4) Principles of Accounting

The auditor must check that the capital and income transactions are properly distinguished. All financial transactions must fall into one of two categories: revenue or capital. The auditor must also verify the accuracy of both income and expenditure items.

5) Assets Verification

All of the company’s assets must be physically verified by the auditor. As a result, he must examine all legal documents, certifications, official statements, and other documents to determine the ownership of all assets. The auditor must also make certain that no assets are missing from the balance sheet.

6) Liabilities Verification

The auditor must also verify the organization’s liabilities. He’ll go over all of the documents, letters, and certificates once again. He can also seek confirmation from outside parties if necessary.

7) Attestation

A paper trail is left behind by every financial transaction. These supporting documentation must be examined by the auditor to ensure that the transactions are valid and accurate. Vouching is the term for this. The organisation, for example, has a 12,000/- electrical expense. The auditor must then examine the electrical bill to double-check the transaction.

8) Statutory Obligations

The auditor’s job is to ensure that the company’s financial records conform with all laws, rules, and regulations in effect at the moment. As a result, he must ensure that the accounts are compliant with the Companies Act 2003, the Income Tax Act 1961, and other relevant laws.

Features of Auditing

The images tell about the essential features of an audit.

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Characteristics of Auditing

• It is a systematic procedure of examining the financial records of an organization

• Its main objective is to find out any frauds or errors in the financial records.

• It is conducted either by the auditors who have in-depth knowledge of accounting procedures and legal formalities.

• It ensures the truth and fairness of the financial statements if it reflects the exact status of the state of affairs of the business.

• It also ensures that the statements follow the accounting standards.

The term equilibrium defines a state of rest from where there is no tendency to change anything. A consumer is observed to be in the state of equilibrium when he/she does not aspire to change his/her level of consumption i.e. when he/she attains maximum satisfaction. Therefore, consumer equilibrium refers to the situation when the consumer has attained maximum possible satisfaction from the number of commodities purchased given his/her income and price of the commodity in the market. Read the article below to understand more about consumer equilibrium.

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What is Consumer Equilibrium?

A consumer is said to be in an equilibrium state when he feels that he cannot change his situation either by earning more or by spending more or by changing the number of things he buys. A rational consumer will purchase a commodity up to the point where the price of the commodity is equivalent to the marginal utility obtained from the thing.

If this condition is not fulfilled, the consumer will either purchase more or less. If he purchases more, the MU will fall and situations will arise when the price paid will exceed marginal utility. In order to prevent negative utility, i.e. dissatisfaction, he will reduce his consumption and MU will go on increasing till price = marginal utility.

On the other hand, if marginal utility is greater than the price paid, the consumer will enjoy additional satisfaction from the unit he has consumed beforehand. This will urge him to buy more and more units of commodity leading to successive falls in MU till it gets equal to price. Hence, by buying more or less quantity, a consumer will eventually reach a point where P= MU. Here, his total utility is maximum.

Importance of Consumer Equilibrium

• It enables consumers to maximize his/her utility from the consumption of one or more commodities.

• It helps the consumers to arrange the combination of two or more products based on consumer taste and preference for maximum utility. 

What are the Assumptions for Attaining Consumer Equilibrium in the Case of Single Commodity?

In the case of a single commodity, let’s assume:

• The purchase would be restricted only to the single commodity

• The price of the commodity is already given in the market. The consumer only determines how much he needs to purchase at a given price.

• Being a rational human being, the goal of a consumer is to maximize the consumer surplus which implies the surplus of utility he earns over his expenditures on the good at the point of purchase.

• There are no limitations on the consumer expenditure i.e. he has sufficient money to buy whatever quantity he decides to buy at a given price.

What are the Assumptions for attaining Consumer Equilibrium in the Case of Two or More Commodities?

In the case of two or more commodities, let’s assume:

• The consumer purchases only two goods i.e. A and B.

• The price of both the goods is already given in the market. The consumer cannot change or influence the price of both the goods. He can only decide how much to buy of these goods at a given price. 

• The consumer’s income to be spent on these goods is already given and is constant.

• The consumer is a rational human being and his goal is to maximize the (cardinal) amount of utility from his purchase and consumption of the goods subject to his constraints.

What are the Conditions for Consumer Equilibrium in the Case of Single Commodity?

In the case of a single commodity, the consumer equilibrium can be explained on the basis of the law of diminishing marginal utility. The law of diminishing marginal utility states that as consumers consume more and more units of commodities, the marginal utility derived from each successive unit goes on diminishing. Therefore, how consumers decide how much to purchase depends on the following two factors.

While purchasing a unit of a commodity, a consumer compares the price of the given commodity with its utility. The consumer will be at an equilibrium stage when marginal utility (in terms of money) gets equal to the price paid for the commodity  say ‘X’  i.e.

MUx = Px

Note: Marginal utility in terms of money is calculated by dividing marginal utility in utils by marginal utility of one rupee. 

In case MUx > Px, 

In the case when MUx is greater than price, the consumer goes on buying the commodity because she is paying less for each additional amount of satisfaction he is getting. As she buys more, MU will fall and situations will arise when the price paid will exceed marginal utility ( the concept of the law of diminishing marginal utility is applied here). In order to avoid this situation i.e. dissatisfaction, he will minimize his consumption and MU will go on increasing till MUx = Px. This is the state of equilibrium.

In case MUx < Px, 

In the case when MUx is less than price,, the consumer will have to minimize his consumption of the commodity to raise his total satisfaction till MU becomes equal to price. This is because she is paying more than the additional amount of satisfaction she is getting.

In the case of a single commodity, the consumer equilibrium can be well-explained with the help of an example given below.

Example:

In the below example, assume that the consumer wants to buy goods that are priced at Rs.10 per unit. Also, assume that MU obtained from each successive unit is determined. Assume that 1 util is equals to Re.1

 

In the above table, we can see that the consumer will be at equilibrium when he buys 3 units of commodity X. He will increase his consumption beyond 2 units as MUx > Px. The consumer will not consume 4 units or more of the commodity X as MUx < Px.

What are the Conditions for Consumer Equilibrium in the Case of Two or More Commodities?

The law of diminishing marginal utility is not applied in the case of two or more commodities. In real-life scenarios,  a consumer normally consumes more than one commodity. In such a situation, the law of equity-marginal utility is applied as it helps him to determine the optimum allocation of his income. The law of equi-marginal utility states that a consumer should spend his limited income to purchase different commodities in such a way that the last rupee spent on each commodity provides him equal marginal utility in order to attain maximum satisfaction.

According to the law of equi-marginal utility, a consumer will be in equilibrium when the ratio of marginal utility of one commodity to its price is equal to the ratio of marginal utility of another commodity to its price.

Let us assume that consumers buy two goods i.e.  X and Y.  Then the equilibrium price stage will be at

MUx/Px = MUY/PY = MU of the last rupee spent on each commodity or simply can be said MU of Money.

[frac{MUx}{Px}] =  [frac{MUy}{Py}] = [frac{MUz}{Pz}]= MU[_{money}]   – MU[_{money}]

Similarly, if there are three commodities i.e. X, Y, Z then the condition of equilibrium, in this case, will be simply MY Money. 

Thus, to attain an equilibrium position

1. Marginal utility of the last rupee spent on each good is the same. 

2. Marginal utility of a commodity falls as more of it is consumed.

Let us understand the consumer’s equilibrium in the case of two commodities with an example. Suppose a consumer has to spend ₹. 24 on two commodities i.e. X and Y. Further, assume that the price of each unit of X is 2 and that of Y is 3 and his marginal utility schedule is given below.

To attain the maximum satisfaction from spending his income of ₹. 24, the consumer will buy 6 units of X by spending Rs. 12 ( 2 × 6 = Rs.12) and 4 units of Y by spending Rs. 12 ( 2 × 6 = Rs. 12). 

This combination of goods gives him maximum satisfaction (or state of equilibrium) because a rupee worth of MU in the case of good X is 5 i.e.

[frac{MUx}{Px}] = [frac{10}{2}]

In the case of good Y also. It is 5 i.e.

[frac{MUy}{Py}] = [frac{15}{3}]

(= MU of the last rupee spent on each good)

Note: Consumer’s maximum satisfaction is determined by the budget constraints i.e. the amount of money spent by consumers (₹24 in this example).

Conclusion

To sum up what consumer equilibrium is? Consumer Equilibrium refers to the situation when a consumer is enjoying maximum satisfaction with limited income and has no propensity to change his way of existing expenditure. The consumer has to pay a price for each unit of the commodity he consumes. So, he cannot purchase or consume an unlimited quantity of commodities. In the case of a single commodity, the consumer attains an equilibrium position when the marginal utility of a good in terms of money gets equivalent to the price of that good.