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Fundamental principles of costing

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What is Consumer's Equilibrium

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1.       Every consumer is faced with a common problem: how to spend his limited income on one or two goods so as to get maximum satisfaction out of the expenditure incurred.
2.       Consumer’s equilibrium is defined as a situation when a consumer allocates his income on one or two goods in such a way that he gets maximum satisfaction.
3.       There are two alternative approaches for the attainment of consumer’s equilibrium, namely
(i)                  Utility approach and
(ii)                Indifference curve approach.
4.       The utility approach, also known as cardinal utility approach provides an explanation to the consumer’s equilibrium by making use of the of utility, total utility, marginal utility, law of diminishing marginal utility and law of equi-marginal utility.
5.       Utility is the most satisfying power of a commodity. In other words, utility is the amount of satisfaction which consumer derives from the consumption of a good. There are two concepts of utility: (I) total utility and (II) marginal utility.
6.       Total utility is defined as the total satisfaction a consumer obtains from a given amount of a particular commodity. Total utility is the sum of the marginal utilities obtained from the consumption of different units of a commodity, I.e., TU=MU1+MU2+……MUn=∑MU.
7.       Marginal utility is an addition made to total utility by consuming an additional (extra) unit of a commodity. Symbolically, MU=ΔTU/ΔQ or MUnth= TUn-TUn-1.
8.       Relationship between TU and MU:
(i)                  So long as MU is positive, TU rises,
(ii)                When MU becomes zero, TU is maximum and
(iii)               When MU is negative, TU falls.
9.       Law of diminishing marginal utility is the fundamental law of utility approach to consumer’s equilibrium. This law states that as more and more units of a commodity are consumed, the marginal utility obtained from each successive unit goes on diminishing.
10.   Law of equi-marginal utility states that the consumer, in order to maximize his satisfaction, should spend his money on two goods in such a manner that the ratio of marginal utility of a commodity to its price becomes equal to the ratio of marginal utility of the other commodity to its price.
11.   Consumer’s equilibrium through utility approach. The attainment of consumer’s equilibrium through the utility approach is studied under two headings (i) one commodity case and (ii) two commodities case.
(i)                  In case of a single commodity, the consumer attains equilibrium when the marginal utility derived from the consumption of a commodity becomes equal to its price. Mathematically, the condition for consumer’s equilibrium given by utility approach is expressed as,
                                                 MUx=Px
In this equilibrium position, the consumer gets maximum satisfaction. Graphically, the consumer’s equilibrium in case of one commodity is shown:
(ii)                In case of two commodities, the consumer attains equilibrium when the ratio of marginal utility of a commodity to its price becomes equal to the ratio of marginal utility of the other commodity to its price. Mathematically, the condition for consumer’s equilibrium in case of given by the utility approach is expressed as:
                                        MUx/Px= MUY /PY
This is however, subject to the budget constraints that the money spent first equals income, i.e.,
                                 Px .Q x +Py .Q y = M(income)
Graphically, the consumer’s equilibrium in case of two commodities is shown as:
fig.1 Consumer equilibrium in single commodity

12.   Consumer’s equilibrium through indifference curve approach; prof.J.R.Hicks and  R.G.D. Allen have explained consumer’s equilibrium in case of two commodities by making use of the concepts of indifference map and budget line (or price line).
(i)                  Indifference map. A set of indifference curve drawn according to different levels of satisfaction is called an indifference map. An indifference curve shows the different combinations of two goods which gives equal satisfaction to the consumer. The consumer is indifferent about the combinations.
(ii)                Budget line. Budget line (or price line)  shows the different combinations of two goods which the consumer can actually purchase in the the market with his given income and price of the two commodities.
fig.2 Consumer equilibrium in two commodities

Consumer’s equilibrium. According to indifference curve approach, a consumer is in equilibrium at a point where the budget line is tangent to indifference curve, i.e., the point where the slope of the indifference curve is equal to the slope of the budget line. Mathematically, the condition for consumer’s equilibrium given by the indifference curve approach is expressed as:
                                                    MRSxy=Px/Py



Also Read
Introduction to Micro-economics
Marketing Concept 


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