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Unit II Consumer’s Equilibrium
Utility -> Want satisfying power of a commodity.
Total Utility (TU) -> Total satisfaction a consumer obtains from the consumption of a
given amount of a particular commodity. TU = ∑ MU
Marginal Utility (MU) -> Change in total utility resulting from the change in
consumption by an additional unit. MU = TU / C
Relation : TU & MU
(i)
When TU rises, MU positive
(ii)
When TU is maximum , MU = 0
(iii) When TU falls , MU < 0
Law of diminishing marginal utility (LDMU) -> It states that as more and more units
of a commodity are consumed MU obtained from each successive units goes on
diminishing. MU curve is a downward slopping curve.
Consumer Equilibrium -> A situation when consumer gets maximum satisfaction by
spending his given income for the consumption of goods and feels no urge to change
his consumption.
Conditions of consumer equilibrium through utility approach (in case of single
commodity consumption) ->
(i) MUx = Px (in case of single commodity consumption)
OR
MUx / MUM = Px
i.e MUx in terms of money = Price of X
** Process of reaching consumer equilibrium in case of single commodity ->
PX
# If MUX > P X , consumer will increase consumption
E
# If MUX < P X , consumer will reduce consumption
*
PX
# Consumer will be in equilibrium when MUX = P X
MU < P
qe
Qty
MU
Unit of X
01
02
03
P of X
5
5
5
MU of X
8
5
3
Remarks
MU > P , Increase in consumption
MU = P , Consumer Equilibrium
MU < P , Fall in consumption
8 Conditions of consumer equilibrium through utility approach (in case of two
commodities) ->
(i)
MUx / Px = MUy / Py subject to Px . X + Py . Y = M
** Process of reaching equilibrium in case of two commodities ->
# If MUx / Px > MUy / Py , the consumer will increase consumption of X and
decrease consumption of Y till MUx / Px = MUy / Py
# If MUx / Px < MUy / Py , the consumer will decrease consumption of X and
increase consumption of Y till MUx / Px = MUy / Py
9 Conditions of consumer equilibrium through IC approach ->
(i)
Slope of IC = Slope of budget line i.e MRSxy = Px / Py
(ii)
IC is convex to the origin i.e MRS is diminishing.
** Explanation of consumer equilibrium through IC approach ->
E : equilibrium point (on IC2 ) which shows the combination at which
Slope of Budget Line = Slope of IC
i.e. Px / Py = MRSxy
# Consumer will never choose any combination of goods on lower IC (like IC1)
because it will give him less satisfaction
# Consumer cannot choose any combination of goods on higher IC (like IC3) as
it is beyond his money income. He cannot afford to buy.
10 Indifference Curve -> A curve that shows the different combinations of two goods
which gives equal satisfaction to the consumer. The consumer is indifferent about the
combinations.
11 Indifference Map -> A set of Indifference curves drawn according to different levels
of satisfaction. Higher indifference curve shows higher level of satisfaction.
12 Budget Line -> A budget line OR price line shows the different combinations of two
goods which the consumer can actually purchase in the market with his given income
and price of the two commodities.
13 Budget Set -> It is the attainable combinations of a set of two goods, given the
prices of the goods and income of the consumer.
14 Properties of Indifference Curve ->
(i) An IC slopes downward – If the consumer wants to have more units of one
good, he will have to reduce the consumption of other good in order to maintain the
same level of satisfaction.
(ii) An IC is convex to the origin i.e. MRS is Diminishing – The consumer is willing
to give up less and less unit of one good for an increment in the other (MU of the
other falls with increase in consumption). MRS falls due to law of diminishing MU.
(iii) Two ICs do not intersect each other.
UNIT II Demand and Elasticity of Demand
15 Demand  The quantity of a commodity the consumer is willing to buy at a
particular price during a particular period of time.
16 Determinants of demand ->
•
Price of the commodity – Inverse relationship between price of the commodity &
its quantity demanded.
• Prices of Related commodities – Two cases
(i) Substitute Goods ( one good can e used in place of other . eg. Tea & Coffee) –
Direct relation between price of a commodity & demand for its substitute. When
price of Tea rises, demand for coffee rises and vice versa.
(ii) Complementary Goods (two goods should be consumed together . eg. Petrol &
Car) – Inverse relation between price of a commodity & demand for its
complementary good. When price of Petrol rises , demand for car falls and vice
versa.
• Income of the consumer – (Two cases)
(i) Normal Good – Demand for the normal good increases with increase in income
of the consumer and vice versa. Direct relation between Income of the consumer
and demand for Normal good.
(ii) Inferior Good – Demand for the inferior good decreases with increase in
income of the consumer and vice versa . Inverse relation between Income of the
consumer and the demand for Inferior good.
. Taste & preferences of the consumer – Favourable changes in taste & preferences
of the consumer increases demand for a commodity and vice versa. Direct relation.
. Expectation of consumer about future change in price of the commodity – Direct
relation
. Size of population – When the size of population increases, total demand for a
good increases . Direct relation.
17 Law of Demand ->
• Statement – Other factors remaining same the demand for a good is inversely related
to its price.
• Example – Px 10 20 30
Qx 35 25 15
• Diagram – Inverse relation is represented by downward sloping demand curve.
Px
Other factors : income, price of substitutes , tastes etc
d
Qx
18 Reasons behind Law of demand / Inverse relationship between price of a
commodity & its quantity demanded / Downward slope of demand curve :1. Application of Law of Diminishing MU –
2. Income effect –
3. Substitution effect –
4. Change in number of consumer 19 Change in Quantity Demanded -> Qty demanded changes due to change in price of
the commodity. (Two cases)
• Expansion of Demand – Other things remaining same , demand for a commodity
rises with fall in its price . Represented by downward movement along the demand
curve. Eg. Px : 10 05 Qx : 15 20
• Contraction of Demand – Other things remaining same , demand for a commodity
falls with rise in its price. Represented by upward movement along the demand
curve. Eg. Px : 05 10 Qx : 20 15
20 Change in Demand -> (Qyt demanded changes at the same price due to change in
other factors)
(A) Increase in demand 
. Meaning : When higher quantity of a commodity is demanded at the same price due
to change in other determinants of demand like increase in income etc
. Example : Px 10 10
Qx 20 30
. Specific reasons : Change in determinants other than the price of the commodity
eg. Increase in Income, Rise in price of substitute good, Fall in price of complementary
good, Favourable change in taste & preference of the consumer etc.
. Diagram : Represented by rightward shift of demand curve.
(B) Decrease in demand ->
. Meaning : When lower quantity of a commodity is demanded at the same price
due to change in other determinants of demand like decrease in demand etc.
. Example : Px 10 10
Qx 30 20
. Specific reasons : Change in determinants other than the price of the commodity
eg. Decrease in Income, Fall in price of substitute good, Rise in price of complementary
good, Unfavourable change in taste & preference of the consumer etc.
. Diagram : Represented by leftward shift of demand curve.
21 Giffen good -> Special type of inferior good whose demands rises with increase in
price .
22 Price Elasticity of Demand ->
•
Meaning : It is a measure of degree of responsiveness of demand for a commodity
to change in its price.
23 MEASUREMENT OF ELASTICITY OF DEMAND ->
• Total Expenditure Method  Elasticity is measured on the basis of nature of change
in total expenditure on the commodity due to change in its price.
SL
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2
3
Description
If Price & Total Expenditure
change in opposite direction
If Price & Total Expenditure
change in same direction
With change price , no
change in total expenditure
Ed
Ed > 1
Term Used
Elastic demand
Ed < 1
Inelastic demand
Ed
Unitary elastic demand
=1
• Point Method  Price elasticity varies from point to point on a st line downward
slopping demand curve.
• Price A (Ed = ∞)
E(Ed >1)
C (Ed = 1 : C - Mid-point)
D (Ed < 1)
B(Ed=0)
Qty
Elasticity of Demand = (Lower part / Upper part) of demand curve
(i)
At A , Ed = AB/0 = infinity
(ii)
At E, Ed = EB / AE >1 ( since EB > AE )
(iii) At C , Ed = CB / AC = 1 ( since CB = AC )
(iv) At B , Ed = 0 / AB = 0 AND (v) At D , Ed = DB/AD <1 (since DB < AD)
• Percentage Method 
• Ed = % change in Qty demanded / % change in Price
= ( Q / P ) X P/Q
• The absolute value of the coefficient of elasticity of demand ranges from Zero to
Infinity.
24 Factors affecting Price Elasticity of Demand ->
•
Availability of close substitutes in market - If large no of substitutes are available in
the market , demand will be highly elastic
•
Nature of commodity – necessary ( inelastic demand ) / luxury (elastic demand)
•
Income level of the consumers - Very high income & very low income (inelastic
demand) / Middle income (elastic demand)
•
Proportion of total expenditure spent on the product.
 Time period needed to find substitute
Degrees of Elasticity of Demand
Ed
Type
of Ed
Description
Type of
Good
Shape of
Demand
Curve
Ed = 0
Perfectly
Inelastic
No change in Qty
demanded due to change
in price
Essentials of Vertical St Line
life
0 < Ed < 1
Inelastic
% change in demand < %
change in price
Necessities
of life
Downward
sloping steeper
Ed = 1
Unitary
Elastic
% change in demand = %
change in price
Normal
goods
Rectangular
hyperbola
1 < Ed < ∞
Elastic
% change in demand > %
change in price
Luxuries
Downward
sloping flatter
Ed = ∞
Perfectly
Elastic
Infinite change in demand
without any change in
price
Imaginary
(under PC)
Horizontal