Consumer Equilibrium 25h67

Consumer Equilibrium Indifference map shows the tastes and preferences of the consumer independently of the market conditions, i.e., what the consumer would like to do. On the other hand, the budget line represents the purchasing power or opportunities open to the consumer in the market, given his income and prices of the commodities, i.e. what the consumer is able to do. The indifference map and the budget line are quite independent of each other so long as the consumer does not start making purchases in the market. However, both of these instruments are important in the determination of consumer equilibrium or in predicting what consumer will actually do, i.e., how the consumer spends his money in the pursuit of his needs and interests. Every consumer wants to maximize the satisfaction. But, income constraint sets limits to his maximizing behavior. The consumer who wants to get the most for his income would like to land on as high an indifference curve as his purchasing power permits, i.e., the highest indifference curve which can be reached from his budget line. To get the consumer's equilibrium, the budget line is super- imposed upon the indifference map. Consumer is said to be in equilibrium, where he maximizes the satisfaction, subject to his budget or income constraint. Consumer equilibrium is graphically illustrated in Fig.In this figure, AB is the budget line. Consumer can choose any combination of commodities 'X' and' Y'. Four indifference curves IC1, IC2, IC3 and IC4, out of the indifference map of the consumer are also shown in this diagram. All combinations of the commodities beyond the budget line and hence indifference curves IC3 and IC4 are not within the reach of the consumer. He would not like to choose a combination below this budget line, as it will not give maximum possible satisfaction to the consumer. Therefore, in any case, consumer equilibrium must lie on the budget line. But, -C' and 'D' points on the budget line will not ensure maximum possible satisfaction to the consumer, since these points lie on a lower indifference curve IC. and it is possible to reach a combination of commodities on a higher indifference curve IC2 with the same money income.

Fig. : Consumer Equilibrium

Indifference curve IC2 is the highest indifference curve that the consumer can reach, given his budget constraint. The budget line touches this indifference curve at point 'E'. This is the point of consumer equilibrium, where the consumer purchases OM quantity of commodity 'X' and ON quantity of commodity 'Y’ All other points on the budget line to the left or right of point 'E' lie on lower indifference curves and thus indicate a lower level of satisfaction .Thus, given the budget constraint, the consumer maximizes his satisfaction at the point, where his budget line is tangential to an indifference curve. The budget line can be tangent to one and only one indifference curve. It we draw a budget line, which is tangent to two or more indifference curves, it would necessitate intersection of the curve, which is against the properties of indifference curves.

CHANGES: Consumer Equilibrium, Changes in Prices The consumer's choice of how much to consume of various goods depends on the prices of those goods. If prices change, the consumer's equilibrium choice will also change. To see how, consider again the example considered above where the consumer must decide how much to consume of goods 1 and 2. Suppose that the price of good 1 increases from $2 per unit to $3 per unit, while the price of good 2 remains unchanged at $1 per unit. Everything else remains the same; the consumer's budget is still $5, and the marginal utility that the consumer receives from each additional unit of goods 1 and 2 is unchanged. However, the ratio of the marginal utility of good 1 to the price of good 1 is now changed, due to the increase in the price of good 1. The new situation is reported in Table 1 . TABLE 1 Illustration of Consumer Equilibrium. Price of good 1 = $3, Price of good 2 = $1, Budget = $5 Units of good 1 MU of good 1 MU/price of good 1 Units of good 2 MU of good 2 MU/price of good 2 1

24

8

1

9

9

2

18

6

2

8

8

3

12

4

3

5

5

4

6

2

4

1

1

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