[Commerce Class Notes] on Consumer Equilibrium Pdf for Exam

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.