[Commerce Class Notes] on Consumer Equilibrium in Case of Two Commodity Pdf for Exam

The term equilibrium implies the state of rest and there is no tendency to change. The equilibrium means the position of rest, which delivers maximum satisfaction or benefit under a given situation. A consumer is said to be at equilibrium when he does not intend to change his level of consumption i.e. when he derives maximum satisfaction. In other words, consumer equilibrium refers to a situation when a consumer attains maximum satisfaction with limited income and has no tendency to change the existing way of his expenditures.

Therefore, a rational consumer aims to balance his expenditures in such a way that he can attain maximum satisfaction with minimum expenditure. When he intends to do this, he is said to be in equilibrium. At the point of equilibrium, there are no incentives left with the consumers to make any changes in the quantity of the commodity purchased.

It is also assumed that consumers know the different goods on which they need to spend their income and the utility they are likely to get out of consuming such commodities. It implies that the consumer has perfect knowledge of different alternatives available to him.

The Concept of Consumer Equilibrium in Case of Two Commodities

The law of diminishing marginal utility that is applied only in the case of a single commodity, states that as more and more commodities are consumed, the marginal utility derived from each successive unit goes on diminishing. But in real-life situations, a consumer normally consumes more than one type of commodity. Therefore, in the case of two commodities, the law of equi-marginal utility is applied which helps consumers to optimally allocate their income. The law of equi-marginal utility states that a consumer will attain equilibrium when the ratio of marginal utility of one commodity to its price is equal to the ratio of the marginal utility of another commodity to its price.

Let a consumer buy two commodities i.e. X and Y. Then at equilibrium

[frac{Mux}{Px}] = [frac{Muy}{Py}] = Marginal utility of the last rupee spent on each good or simply Marginal utility of money (MUM)

Similarly, if a consumer buys three commodities such as X, Y, and Z, then the condition of equilibrium will be the simply marginal utility of money or MU of money.

[frac{Mux}{Px}] = [frac{Muy}{Py}] = [frac{Muz}{Pz}] = MU [_{money}] – MU [_{money}]

Therefore to be in equilibrium,

 

Let us now understand the consumer equilibrium in the case of two commodities with an example:

Suppose a consumer has only Rs.24 with him to spend on two commodities i.e. X and Y. Further, also assume that the price of each unit of good X is Rs.2 and the price of each unit of good Y is Rs.3. The marginal utility schedule of this example is given below.

From the above table, it is concluded that the consumer will get maximum satisfaction from spending his total income of Rs.24 if he buys 6 units of good X by spending Rs. 12 ( 2 6 = 12) and 4 units of good Y by spending Rs. 12 ( 3  4 = 12). This combination will provide maximum satisfaction to consumers (or state of equilibrium) because a rupee worth of MU in case of commodity X is 5 ( MUx/Px = 10/2 = 5) and in the case of commodity Y is also 5 

( MUy/Py = 15/3 = 5) 

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

It is important to note that maximum satisfaction of consumers is subject to budget constraints i.e amount of money spent by the consumer. In this example, Rs.24 is the total amount that a consumer will spend to buy two commodities i.e. X and Y.

What Happens When a Consumer is Not in an Equilibrium Position?

Assume that [frac{Mux}{Px}] > [frac{Muy}{Py}] . This implies that MU from the last rupee spent on commodity X is greater than the MU of the last rupee spent on commodity Y.  This encourages the customer to transfer his expenditure from commodity Y to commodity X. As a consequence, MU rises and MUx falls. The process of transfer of expenditure on commodities continues until [frac{Mux}{Px}] = [frac{Muy}{Py}] .