Consumers equlibrium

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MICROECONOMICS
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' |TITLE= CONSUMERS EQULIBRIUM }} 

{{Case_study|Enter your text here The consumer attains equilibrium when he is able to consume the most preferred commodity bundle which gives him highest utility.It is a state of stability where there is no tendency to rearrange the combinations of goods preferred by the consumer. The limitation on utility maximization is evident.We want to reach the highest indifference curve with our limited income.We can go only as far as our budget constraint allows.Suppose we have only 50 rupees to spend on good X and good Y .The price of good X is 10 rupees where as the price of good Y is 5 rupees. We can have as many as5 units of good X if we want for sake good Y.Similarly you can have 10 units of good Y and no units good X.The budget constraints illustrates all combination of goods you can buy with a limited income. In this case the budget line illustrates the combination of X and Y, that can be purchased with r 50.

P G

Q2		           E IC3 H 	       IC2 IC1 0       Good  X       Q1                       L

Fig – 1, explain the process of consumer’s equilibrium. The consumer’s preference scale is described by means of indifference mapping.Then we impose a budget line that reflects our income. In this case we have r 50 and the price of good X and good Y is r 10 and r 5 respectively. Therefore, we can afford only those combinations that are on or inside the price line PL. In this diagram every combination i.e. G,E,H on the price line PL cost you the same amount of money. In order to maximize the utility, we will try to reach the highest indifference curve which you could get with a given expenditure of money and given prices of two goods. The budget line touches IC2 at point E represents the most utility. This is the highest attainable indifference curve with which you can get OQ1 units of good X and OQ2 units of good Y for r 50. Any other affordable combinations like G and H gives you less satisfaction, because that is on a lower indifference curve IC1. With this we conclude that the point of tangency between the budget line and an indifference curve represents optimal consumption. It is the affordable combination that maximize our utility. MARGINAL UTILITY AND PRICE : - The slope of the indifference curve shows the marginal rate of substitution of good X for good Y, while the slope of price line indicates the ratio between prices of two gooods i.e. ( PX /PY). Consaumer equilibrium was represented as the combination of good X and good Y can be written as MU of Good X           MU of Good Y   = Price of X                  Price of Y

Alternatively,

MU of Good X         Price of X   = MU of Good Y         Price of Y

This equation explains that at the point of equilibrium the relative marginal utilities of good X and good Y should equal to their relative prices. In other words, if good X cost twice as much as good Y , then marginal utility of good X must yield double , then the consumer is in an optimal state.

The slope of the budget constraint equal the relative prices of the two goods. In Fig-1, the slope of the price line equal to the price of goods X and good Y. It means the rate of substitution between the good X and good Y is 1:2.

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