Introductory Economics

Consumer’s Equilibrium: Case of a Single Commodity

Consumer’s Equilibrium: Case of a Single Commodity-
When consumer is consuming a single commodity he compares utility derived from each unit of the good consumed (MU) with the money paid for it (Price). He consumes the next unit if MU is greater or at least equal to the price. He stops at the point where for the next unit MU is less than the price.

Therefore the necessary conditions in the consumers’ equilibrium when he consumes a single commodity are:

MU_x = P_x

MU_x is less than P_x for the next unit as MU is a downward sloping straight line.
In a single commodity case, a consumer makes purchases only up to the point where marginal utility of the last unit is equal to the price of that unit.

Consumer's equilibrium = MU_x = P_x

No. of Units Consumed	Px	MU
1	10	25
2	10	20
3	10	15
4	10	10
5	10	5
6	10	0
7	10	-5

• Above table, shows that if P_x = Rs 10 then the consumer will buy 4 units of good x if he purchases less than 4 units say 3 units then the MU he derives from 3 units is worth Rs 15 and the price he pays is Rs10.
• Since MU_x > P_x, he purchases more. In other words since price is less he purchases more which is the logical basis of the law of demand.
• A consumer will not buy more than 4 units of X this is because if he purchases 5 units of x then the price he pays will be more than the MU he derives which is worth Rs 5. Hence in order to maximize utility a consumer will buy that commodity of good where MU of the good x is equal to the price which he has to pay for it.

 

Thus at Consumers equilibrium

MU_x = P_x

The consumer’s equilibrium can be explained graphically as given below. The consumer will be at equilibrium at point E where MU_x = P_x The. Equilibrium Price is given at 10 and equilibrium quantity is given as 4.

Consumer’s Equilibrium: Case of More than One Commodity:

• More realistic is the situation where the consumer consumes more than one commodity. In such a situation the consumer compares MU of last unit of money (e.g. Rupee) spent on different goods, which are calculated by dividing MU of a good by its price. The consumer reaches the equilibrium i.e. gets maximum satisfaction at the point where following two conditions are satisfied.
• Law of Equi-Marginal Utility: It means MU of last unit of money (e.g. Rupee) spent on each good is same.

• The term ‘equi-marginal utility’ does not refer to the equalities of marginal utilities (MU_x or MU_y) of different goods, but marginal utility of the last rupee spent on each good, which is calculated by dividing MU of a good by its price.
• Law of Diminishing Marginal Utility, which states that as the consumer consume more and more units of a commodity the marginal utility of the commodity falls.

• it means that good ‘x’ is giving more satisfaction to the consumer as compared to good ‘y’. Therefore the consumer would gain satisfaction by consuming more of good ‘x’ and less of good ‘y’.
• As he consumes more of good ‘x’, MU_x will fall which would lead to fall in MU_x/ P_x. Similarly MU_y will rise as he consumes less of good ‘y’. This would increase MU_y/ P_y. This process will continue till we reach the equilibrium point where

• The consumer would increase the consumption of good ‘y’ and reduce the consumption of good ‘x’ till he reaches the equilibrium point where

• Law of Equi-marginal Utility: Marshall states the law of equi – marginal utility as under; if a person has thing which he can put to several uses, he will distribute it among these uses in such a way that it has the same marginal utility in all. This law is known as law of equi – marginal utility because when the marginal utility has been equalized through the process of substitution, we derive maximum satisfaction.
• This law is also known as law of substitution because here we substitute one commodity for another.

ASSUMPTIONS: The law of equi-marginal law is based on the following assumptions:

• All consumers attempt to maximize their economic satisfaction
• Consumer has limited money to spend
• Utility is cardinally measurable
• Marginal utility of money remains constant
• Income, habits, attitudes etc of the consumer does not change.

EXPLANATION OF THE LAW

• With the given income ,the consumer will go on purchasing goods until the marginal utility of expenditure on each good becomes equal and his given income is fully spent.
• In other words, consumer will maximize his utility by allocating his given income in such a way that the marginal utility of the last rupee spent on each good he consumes is the same. Thus the consumer will be in equilibrium when he is spending his given income in such a manner that the following equation holds good:

This can also be explained with the help of table and graph:

Units	MUx	MUy	MUx Px	MUy Py
1 2 3 4 5 6	20 18 16 14 12 10	24 21 18 15 12 9	10 9 8 7 6 5	8 7 6 5 4 3

• Let us assume that the prices of good X and Y are Rs. 2 and Rs. 3 respectively and the consumer has Rs. 24 to spend on these two commodities.
• In order to maximize his utility consumer will equate the Marginal utility of the last rupee spent on these two commodities. In other words he will equate MU_x with MU_y while spending his given income on the two commodities. As it is clear from the above table that MU_x /P_x is equal to 5 utils when the consumer purchases 6 units of commodity X and MU_y/P_y is equal to 5 utils when he purchases 4 units of commodity Y .
• Therefore consumer will be in equilibrium when he is buying 6 units of X and 4 units of Y and will be spending Rs. 24(Rs.2x6 + 3x4) in all. This is the equilibrium position where consumer maximizes his utility. This law can be explained with the help of graph.
• In the above graph MU_x/P_x and MU_y/P_y are measured on vertical axis. The units of commodity X and Y are measured on horizontal axis. The horizontal line a b satisfies the principle of equi marginal utility. When consumer purchases OA units of X commodity and OB units of Y commodity then MU_x /P_x and MU_y /P_y are equal to EO.

Limitation of EMU:

• Utility cannot be measured. Thus it is very difficult for the consumer to know the utility derived from a commodity.
• Habits & custom play a very .important role for consumers thus their decisions regarding buying commodity are mainly governed by habits & customs instead of utility.
• Many consumers are ignorant regarding equilibrium positions & utility derived from the commodities.
• The demand for expensive & indivisible good he adjusted easily. Thus it is not possible to equate the MV on it.
• Marginal utility of money is not constant. As the consumer spends more and more of his income in buying more and more units of the commodity the marginal utility of money income rises.

IMPORTANCE OF THE LAW:

• The law of equi marginal utility helps and guides individuals in spending their limited income. It tells the consumer how to allocate his given income to get maximum satisfaction
• Law is equally important for producers also. It guides them how to distribute resources to get maximum output. In production the law is known as principle of equi marginal returns.
• The government too is guided by this law. Its expenditure should be such that the society should get maximum benefit. Government expenditure is therefore guided by the principle of maximum social profit.