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UNIT 2 Consumer’s Equilibrium and Demand 13 Marks
Topic: -Meaning of utility, marginal utility, Law of diminishing marginal utility, conditions of
consumer’s equilibrium using marginal utility analysis. Budget set and budget line,
indifference curve and indifference map and conditions of consumer’s equilibrium using
Indifference curve analysis.
Demand, market demand, determinants of demand, demand schedule, demand curve and
its slope, movement along and shifts in the demand curve.
Price elasticity of demand, factors affecting price elasticity of demand, measurement of
Price elasticity of demand (percentage method)
Consumer’s Equilibrium
1. Utility- It is want satisfying power of a commodity .It is measured in terms of util.
2. Total Utility- It is total satisfaction obtained from the consumption of all possible
units of a commodity.
3. Marginal Utility- It is the additional utility derived from the consumption of one more
units of the given commodity.
4. Cardinal Utility- The utility which is measured in terms of numbers.
5. Ordinal Utility- The utility which is expressed in terms of rank or order of preference.
6. Law of Diminishing Marginal Utility- It states that as we consume more and more of
a units of a commodity, the utility derived from each successive unit goes on
decreasing.
Assumptions- Cardinal measure, Continuous consumption, rational consumer, No
change in quality, MU of money remain constant, fixed income and prices, etc.
Tabular and Graphical Presentation:-
Units TU MU
1 3 3
2 5 2
3 6 1
4 6 0
5 5 -1
Relationship between TU and MU:-
a) TU is increasing MU decline but remain positive.
b) TU is at its maximum MU becomes zero.
c) TU decline MU becomes negative.
7. Consumer’s Equilibrium using Marginal Utility Analysis:-
A. Single Commodity:-
i) A consumer is in equilibrium when he is having maximum satisfaction with
limited income and has no tendency to change his way of existing expenditure.
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ii) Conditions:- MUx/Px = MUm
MUx – Marginal utility of the commodity x
Px – Price of the commodity x
MUm- Marginal utility of the money
iii) Tabular and Graphical Presentation-
One rupee
Unit MUx =Px one Util
MUm Remark
s
1 20 10 20 MUx > Px
2 16 10 16 MUx > Px
3 10 10 10 MUx = Px
4 6 10 6 MUx < Px
5 0 10 0 MUx < Px
6 -4 10 -4 MUx < Px
The MUx curve is downward sloping because it obeys Law of Diminishing Marginal
Utility. Px is parallel to x-axis as price is constant. The point where MUx and Px intersect,
consumer attains equilibrium. The shaded region represents consumer is in surplus.
B. Two Commodities:-
i) A consumer is in equilibrium when he is having maximum satisfaction with
limited income and has no tendency to change his way of existing expenditure.
ii) Conditions:- For commodity x MUx/Px = MUm …….(1)
For commodity y MUy/Py = MUm ……. (2)
Equating equation (1) &(2), we get MUx/Px = MUy/Py
MUx & MUy – Marginal utility of the commodity x & y.
Px & Py – Price of the commodity x & y.
MUm- Marginal utility of the money.
iii) Tabular Presentation-
Px = 1, Py= 1, M= 9
Unit Mux MUy
Consumer attains equilibrium at 3x + 3y = 6 < 9 (Ignore)
s
1 20 14 Again, Consumer attains equilibrium at 4x + 5y = 9
2 16 12 =9
3 10 10
4 6 8
5 0 6
6 -4 3
Restoration- What happens MUx/Px = MUy/Py?
The consumer will not attain equilibrium and it will lead to two conditions.
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a) MUx/Px > MUy/Py :- As consumer gets more utility from commodity x, so he consumes
more of x due to which MUx decline because of Law of DMU. Simultaneously, he has to
sacrifice some units of commodity y due to which MUy increases because of Law of DMU.
This change continues till he attains equilibrium.
b) MUx/Px < MUy/Py :- As consumer gets more utility from commodity y, so he consumes
more of y due to which MUy decline because of Law of DMU. Simultaneously, he has to
sacrifice some units of commodity x due to which MUx increases because of Law of DMU.
This change continues till he attains equilibrium.
8. Indifference Curve- It is graphical representation of various alternative combinations
of bundle of two goods among which the consumer is indifferent.
Combination Good X Good Y
A 1 10
B 2 6
C 3 3
D 4 1
Properties of Indifference Curve –
i) It is convex to origin because of diminishing MRS.
ii) It slopes downwards because consumer has to sacrifice some units of one
commodity in order to get an additional unit of another commodity.
iii) Higher IC represents higher level of satisfaction because of monotonic
preference.
iv) Two IC’s never intersect each other.
Let us assume two IC intersect at C.
A = C (both lies on the same IC i.e. IC1 ) …….(1)
B = C (both lies on the same IC i.e. IC2 ) ……. (2)
Equating (1) & ( 2), we get A = B, which is not possible.
Therefore our assumption is wrong
Thus two IC’s never intersect each other.
9. Indifference Map- It is the family of indifference curves that represent consumer
preferences over all the bundles of the two goods.
10.Budget Line- It is graphical representation of all possible combination of two goods
which can be purchased with given income and prices, such that the cost of each of
these combinations is equal to the money income of the consumer.
Equation of Budget Line: - M = PxQx + PyQy
Equation of Budget Constraint: - M > PxQx + PyQy
Slope of Budget line: - Px / Py = Price of commodity X / Price of commodity Y
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Shift in Budget Line- It will shift to right when income of the consumer rises and price of
both the commodity falls and vice versa.
Rotation in Budget Line- It will rotate when price of one commodity changes. (Rise or
fall)
Budget set- It is the set of all possible combinations of the goods which a consumer can
afford, given his income and price in the market.
e.g. Income = 12 Px = 2 Py = 3
Budget set: ( 0,4 ) ( 3,2 ) ( 6,0 ) ( 0, 3 ) ( 0,2 ) ( 0,1 ) ( 0,0 ) ( 3,1 ) ( 3,0 ) ( 2,2 ) ( 2,1 )
( 2 ,0 ) ( 1,2 ) ( 1,1 ) ( 1 ,0 ) ( 5,0 ) ( 4,0 ) ( 0,0 )
11.Conditions of Consumer’s Equilibrium using Indifference Curve Analysis-
i) A consumer is in equilibrium when he is having maximum satisfaction with
limited income and has no tendency to change his way of existing expenditure.
ii) Conditions:- a) MRSxy = Px/Py = MRE ……. (1)
MRSxy – Marginal rate of substitution.
Px – Price of the commodity x.
Py - Price of the commodity y.
b) IC is convex to origin because of diminishing MRS.
iii) Graphical Presentation
PQ represents Budget Line. IC1, IC2 & IC 3 represents indifference curve having
different preference. IC is tangent to budget line at point E where consumer attains
equilibrium. Point A – It is not feasible as it lies beyond Budget Line. Point B – It
offers same satisfaction as of Point E but not feasible as it lies beyond Budget Line.
Point C – It is feasible as it lies on Budget Line but due to monotonic preference
consumer has urge to change. Point D - It is feasible as it lies on Budget Line but due
to monotonic preference consumer has urged to change. Point E – Consumer will
attain equilibrium as all conditions are satisfied.
iv) Restoration- What happens when MRSxy = Px/Py?
The consumer will not attain equilibrium and it will lead to two conditions.
a) MRSxy > Px/Py – In this situation the consumer will decrease the
consumption of commodity y and simultaneously increase the consumption
of commodity x. This change will continue till he attains equilibrium.
b) MRSxy < Px/Py – In this situation the consumer will decrease the
consumption of commodity x and simultaneously increase the consumption
of commodity y. This change will continue till he attains equilibrium.
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Demand
1. Difference between Individual Demand and Market Demand.
Individual Demand - It is quantity of a commodity that a consumer is willing and able to
buy, at each possible price during a given period of time.
Market Demand - It is quantity of a commodity that all consumers are willing and able
to buy, at each possible price during a given period of time.
2. Difference between Individual Demand Schedule and Market Demand Schedule.
Individual Demand Schedule - It is a tabular statement showing various quantities of a
commodity that a consumer is willing and able to buy, at various level of price, during a
given period of time.
Price Quantity
1 3
2 2
3 1
Market Demand Schedule - It is a tabular statement showing various quantities of a
commodity that all consumers are willing and able to buy, at various level of price,
during a given period of time.
Price Qty. of A Qty. of B Qty. of C Mkt. Demand
1 3 30 300 333
2 2 20 200 222
3 1 10 100 111
3. Difference between Individual Demand Curve and Market Demand Curve.
Individual Demand Curve - It is graphical presentation of individual demand
schedule. It is steeper in nature.
Market Demand Curve - It is graphical presentation of market demand schedule. It is
flatter in nature.
4. Factors affecting demand: - (Px, Pr, Y, T, F)
i) Price of the Given Commodity- There is inverse relationship between price and
quantity demanded.
ii) Price of the Related Goods- Related goods are of two types.
a) Substitute Goods- Those goods which are used in place of one another. An increase
in price of substitute leads to an increase in the demand for given commodity and
vice versa. (Direct relationship) e.g. tea and coffee.
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b) Complementary Goods- Those goods which are used together. An increase in price
of complementary leads to an decrease in the demand for given commodity and vice
versa. (Inverse relationship) e.g. tea and sugar.
Increase and Decrease in price of Related Goods:-
Increase in price of Related goods Decrease in price of Related goods
iii) Income of the Consumer- The effect of change in income on demand depends on
the nature of the commodity under consideration.
a) Normal Goods- There is a direct relationship between income of the consumer and
demand for normal goods.
b) Inferior Goods- There is an inverse relationship between income of the consumer
and demand for inferior goods.
Increase and Decrease in income of the consumer:-
Increase in Income Decrease in Income
iv) Tastes and Preferences- If it is preferable than demand for commodity increases
and vice versa.
v) Expectations of Change in Price in Future- If price of a commodity is expected to
rise in near future, than people will buy more of that commodity than what they
normally buy. (Direct relationship)
5. Factors affecting Market Demand: - (Px, Pr, Y, T , F, Po, S, D)
i) Size and Composition of Population- Increase in the population raises the market
demand and vice versa. If a market has larger proportion of women, than demand
for cosmetics will more, so composition also decide the demand for a commodity.
ii) Season and Weather- During winter demand for woolen clothes and jackets
increases as season also affect market demand.
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iii) Distribution of Income- If income in the country is equitably distributed, then
market demand for the commodity will be more. However if income distribution
is uneven, then market demand will remain lower level.
6. Law of Demand- It states the inverse relationship between price and quantity
demanded, keeping other factors constant (ceteris paribus).
The reasons for Law of Demand are:- Law of Diminishing Marginal Utility, Substitution
Effect, Income effect, Additional consumers, Different Uses.
Exceptions of Law of Demand are Giffen Goods, Status Symbol, Fear of Shortage,
Ignorance, Fashion Related goods, Necessities of Life, Change in weather.
7. Slope of Demand Curve = Change in Price/ Change in Quantity
8. Difference between Change in Demand and Change in Quantity Demanded.
Change in Demand Change in Quantity Demanded
When the demand changes due to change When the demand changes due to
in any factor other than the own price of change in the price, keeping other
the commodity. factors constant.
It leads to shift in demand curve and law of It leads to movement along the same
demand is not applicable. demand curve and law of demand is
applicable.
Increase in Demand- It is rise in demand for Expansion in Demand- It is rise in
a commodity caused due to any factor demand for a commodity due to fall in
other than own price of the commodity i;e the price, keeping other factors
favourable taste. It causes rightward shift in constant. It causes downward
demand curve. movement in demand curve.
P Q P Q
10 10 10 10
10 20 5 20
Decrease in Demand- It is fall in demand Contraction in Demand- It is fall in
for a commodity caused due to any factor demand for a commodity due to rise in
other than own price of the commodity i;e the price, keeping other factors
unfavourable taste. It causes leftward shift constant. It causes upward movement
in demand curve. in demand curve.
P Q P Q
10 10 10 10
10 5 20 5
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Elasticity of Demand
1. Price Elasticity of Demand- It is percentage change in demand for a commodity
with respect to percentage change in any of the factors affecting demand for that
commodity.
Ed= Percentage change in Demand / Percentage change in Price
2. Factors affecting Price Elasticity of Demand:-
i) Nature of the Commodity- When a commodity is necessity its demand is
inelastic and when it is luxury its demand is elastic.
ii) Availability of Substitute- When a commodity has large number of substitute
its demand is inelastic and vice versa.
iii) Income Level- For any commodity it is inelastic for higher income group and
vice versa.
iv) Habits- The commodity for which consumer is habitual its demand is inelastic
and vice versa.
v) Postponement of Consumption- Commodity whose demand is urgent it is
inelastic and vice versa.
vi) Level of Price- low inelastic and high elastic.
vii) Number of Uses- less inelastic and more elastic.
viii) Share in Total Expenditure- less inelastic and more elastic.
ix) Time Period- less inelastic and more elastic.
3. Measurement of Price elasticity of demand (percentage method)
A. Calculation of Ed by Proportionate Method:-
Ed =
Question. When price of sugar is 5 per Kg, its demand is 50 Kg. When price rises by
5 per kg, its demand falls by 10 Kg. calculate the elasticity of demand.
Answer.
B. Calculation of Ed by Percentage Method:-
Question. As a result of 10 rise in price of a good, its demand falls from 100 units to
90 units. Find out the price elasticity of demand.
Answer.
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C. Calculation of Quantity when Ed is given:-
Question. Price elasticity of demand for a product is unity. Its demand is 25 units at a
price of 5 per unit. If price of product rises to 6 per unit, how much quantity of
the product will be demanded?
Answer.
D. Calculation of Price when Ed is given:-
Question. Price elasticity of demand for a product is unity and a household demands
50 units of It when its price is 2 per unit. At what price will the household demands
45 units of the commodity?
Answer.
4. Degrees of Price elasticity of demand:-
i) Perfectly Elastic Demand- Ed is infinity.
ii) Perfectly Inelastic Demand- Ed is zero.
iii) Unitary Elastic Demand- Ed is one.
iv) Highly Elastic Demand- Ed is greater than one.
v)Highly Inelastic Demand- Ed is less than one.
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