Equilibrium is a state of rest or a position of no change. Consumer equilibrium is a situation in which a consumer derives maximum satisfaction with no intention to change it and is subject to given prices and their given income. In simple terms being in a state of consumer equilibrium means being in a state of maximum satisfaction. Any rational consumer would not deviate from this state of equilibrium. This helps a consumer to maximise the utility from consumption of fewer commodities.
Did you know?
French economist Leon Walras introduced and developed the Consumer Equilibrium theory in the late 19th century.
What is Consumer Equilibrium?
Consumer Equilibrium refers to a state of maximum satisfaction. A situation where a consumer spends his given income purchasing one or more commodities to get maximum satisfaction and has no urge to change this level of consumption is known as the consumer's equilibrium. A state of equilibrium can be achieved by spending money on different goods and services with the given income. At this point, the consumer cannot change his situation by either earning more, spending more, or changing the quantity.
It is assumed that consumers aim to maximise overall utility when deciding how much of a given commodity or service to purchase. The consumer has several limitations when attempting to maximise total utility, the most important of which are the consumer's income and the prices of the goods and services that the consumer wishes to consume.
It allows consumers to get the most out of the consumption of one or more items. It assists customers in combining two or more products for optimal utility based on their tastes and preferences.
Here, the customer is not likely to change his expenditure and units consumed, and they derive the highest utility from the commodities purchased with the given income.
For example, Person "A" to the market and purchases two chocolate bars. They decide to get four extra bars because they anticipate having several guests join them that day. The marginal utility is positive in this situation since They do not need to go back to the market to make a fresh buy and His budget covers the extra things.
Concepts of Consumer Equilibrium
Following are some of the important concepts that one must comprehend in order to get a grasp of consumer equilibrium and how it works. The list is as follows-
- Marginal Utility -Utility is defined as the pleasure or advantage obtained from using a product. The marginal utility of a good or service, on the other hand, explains how much customers like or are satisfied with after increasing or decreasing their use by one unit.
- Law of Diminishing Marginal Utility-According to the economics principle known as the rule of decreasing marginal r, increasing more factors of production would actually lead to lesser improvements in output once a certain level of capacity has been reached.
According to the law of diminishing marginal utility, when consumption rises, the marginal utility gained from each extra unit decreases, all other things being equal. The incremental improvement in utility brought on by consuming one more unit is known as marginal utility.
Conditions of Equilibrium
There are various conditions of equilibrium based on the types & quantities of commodities. Below given are some of them:
1. In case of a Single Commodity
A consumer is said to be in equilibrium when-
- Condition 1 - Rupee worth of satisfaction received by the consumer is equal to the marginal utility of money as specified by the consumer themselves.
While purchasing a unit of a commodity, a consumer compares the price of the given commodity with its utility. The consumer will be at an equilibrium stage when marginal utility (in terms of money) gets equal to the price paid for the commodity say 'X'
MU (of good X) = MU (of money)
OR
PRICE (of good X) = MU (of money)
Note: Marginal utility has to be in terms of money. We get this by dividing the marginal utility of utils by the marginal utility of money in one rupee.
Customers' prices must perfectly match the financial value that MU derives. The consumer should purchase more goods X if the price is less than the marginal utility of money. Increased consumption will cause MU to decline. The Law of Diminishing Marginal Utility applies here. Only when the price of good X equals its marginal utility in terms of money will the consumption of good X end. The consumer should purchase less of good X if the price is greater than its money-based marginal utility. Consequently, the rational consumer will act rationally when the marginal utility and the price paid for the good are equal.
Note: Marginal utility in terms of money is calculated by dividing marginal utility in utils by the marginal utility of one rupee.
- Condition 2- Marginal utility of money remains constant.
The marginal utility of money changes according to the value of money. And if the value of money is constant, there happens to be no respective change. Hence, there is no change in the Marginal Utility of money.
- Condition 3: Law of marginal utility holds good.
Marginal utility is a consumer's additional satisfaction from consuming one more unit of a good or service.
Where M= Marginal Utility of Money,
P= Price, and
E is the Equilibrium Point
A consumer will consume that much quantity at which MUx = Px to be in the state of equilibrium
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2. In case of two commodities
With two or more goods, the law of diminishing marginal utility is not applicable. A customer typically consumes multiple commodities in real-world circumstances. The law of equi-marginal utility is applied in this case because it enables to choose the best way to distribute the income. According to the law of Equi-marginal utility, a consumer should use his or her limited funds to buy various goods so that, to maximise satisfaction, the last rupee spent on each good gives them an equal marginal benefit. The Law of Equi-marginal utility is based on the law of diminishing marginal utility. According to the law of Equi-marginal utility a consumer will be in equilibrium when the ratio of marginal utility of a commodity to its price equals the ratio of marginal utility of another commodity to its price.
Law of Equi-Marginal Utility explains the relation between the consumption of two or more products and what combination of consumption these products will give optimum satisfaction. Marginal Utility is the additional satisfaction gained by consuming one more unit of a commodity.
- The ratio of MU and price is same in case of both the goods. We know that in case of the consumption of a single commodity, say commodity X, the consumer is at equilibrium when, MUM= MUX/PX.
- Similarly, a consumer consuming another commodity, say commodity Y, will be at equilibrium when MU falls as consumption increases. This condition is necessary to attain consumer's equilibrium.
Assumptions of Consumers Equilibrium in the case of two or more commodities
- The consumer purchases only two goods
- The consumer cannot change or influence the price of both goods.
- Only the consumer can decide how much to buy these goods at a given price.
- The consumer's income to be spent on these goods is already given and is constant.
- The consumer is a rational human being, and their goal is to maximize utility derived from the purchase and consumption of the goods subject to their constraints.
3. Consumer's Equilibrium by Indifference Curve Analysis
An indifference curve is a curve showing a combination of goods in which each combination shows the same level of satisfaction derived by the consumer.
On an indifference map, a higher indifference curve represents a higher level of satisfaction than any lower indifference curve. So, a consumer always tries to remain at the highest possible indifference curve, subject to their budget constraint.
Conditions of Consumer's Equilibrium:
The consumer's equilibrium under the indifference curve theory must meet the following two conditions:
Conditions of consumer's equilibrium using indifference curve analysis are
(i) MRS = P X P Y
(ii) IC is convex at the point of equilibrium.
Assumptions:
- The income of the consumer is constant.
- The two goods purchased with income can be substituted for one another.
- The rational customer always aims to maximise their level of satisfaction.
- The price of goods is constant.
- The consumer knows the prices of the commodities.
- Consumer can spend the income in small quantities.
- The market is in perfect competition.
- The goods can be divided.
- The indifference map is well known to the consumer.
We know that a consumer is indifferent among the combinations of the same indifference curve. However, it is important to note that they prefer the combinations on the higher indifference curves to those on the lower ones. This is because a higher indifference curve implies a higher level of satisfaction. Therefore, all combinations on IC1 offer the same satisfaction, but all combinations on IC2 give greater satisfaction than those on IC1.
The consumer weighs the given commodity's price (or cost) against its utility to determine the equilibrium point (satisfaction or benefit). As a rational consumer, they will be in equilibrium when the price paid for the good equals the marginal utility. We know that price and marginal utility are stated in terms of utils. However, it is only possible to compare marginal utility and price when expressed in the same units. As a result, the marginal value of utils is stated in monetary terms. Money-based marginal utility equals marginal utility in utils/M
Similarly, if there are three goods, X, Y, and Z, then the equilibrium condition will be simply MU Money. Thus, to be in equilibrium
1. Marginal utility of the last rupee of expenditure on each good is the same.
2. Marginal utility of a good falls as more of it is consumed.
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Conclusion:
Consumer equilibrium analysis allows consumers to get the maximum consumption of one or more items. It assists customers in combining two or more products for optimal utility based on their tastes and preferences.
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