Class 11th ECONOMICS (Micro Economics Notes) : Chapter 2 Consumer's Behaviour (Utility Analysis & Indifference Curve Analysis

Class 11th MICRO ECONOMICS

Lesson 2       CONSUMER’S EQUILIBRIUM     :  UTILITY ANALYSIS 

                                                                                            (Sunil Dani Jain, Udaipur Raj.)

UTILITY : Wants satisfying power of a good.        OR

            : The quality (Power) of a Commodity / Service that satisfy a human want.

Measurement of utility

1. Cardinal approach : Pr. Marshall

According to this approach utility is measured in terms of Cardinal numbers such as 1,2,3, 4 etc.  This numbers are called Utils (Units of utility).

Law of diminishing marginal utility and law of equi-marginal utility is best upon it.

2. Ordinal approach : J.R. Hicks

According to this approach, utility can not be measured in terms of numbers. it is  only Ranked on the basis of comparison.

Indifference curve analysis of consumer behaviour is based upon it.

TYPES OF UTILITY 

Total Utility (TU) : It is the sum total of utility derived from the consumption of all the units of a commodity.

                          TU = € MU

Marginal utility (MU) : It  refers to additional utility on account of the consumption of an additional unit of a commodity.

      MU = ∆ TU / ∆ Q            or       MU  =  TUn - TUn-1

Q TU MU

1 30 30

2 50 20

3 60 10

4 60 0

5 50 -10

Relationship between TU and MU

• When MU declines (Positive), TU increases.

• When TU is Maximum, MU is  equal to zero.

• When TU starts declines , when MU is negative.

LAW OF DIMINISHING MARGINAL UTILITY : 

       Gossen's first Law of Consumption (1854)

This law is associated more with Pr. Marshall as he made it more popular . 

It is based upon the fact that,  a particular want can be fully satisfied.

• Law of diminishing marginal utility states that is more and more units of a commodity are consumed marginal utility derived from every additional unit must decline.

• It happens in respect of all goods and services . it is therefore called fundamental law of satisfaction or fundamental psychological law.

Assumptions

• Only standard unit of the Commodity are consumed

• Continuous Consumption

• No change in income tests and fashion

• Utility can be measured : Cardinal numbers

CONSUMER’S EQUILIBRIUM : Equi Marginal Utility Analysis

The consumer is in equilibrium when given his income and market prices he plans his expenditure on different goods and services in such a manner that he maximizes his total satisfaction.

A consumers is in equilibrium when he gets maximum satisfaction.

1. ONE COMMODITY CASE

When a consumer buys a single commodity his behaviour is guided by the law of diminishing marginal utility . He will try to consume the commodity up to a point where MU is just equal to its price or ratio of MU and price is equal to MU of money.

Purchase of a commodity by a consumer depends on three factors

• Price of the commodity 

• Marginal utility of the commodity 

• Marginal utility of money.

MUm = MUm refers to worth of a rupee to a consumer it is assume that heat define it in terms of utility that he derived from a standard basket of goods he can buy with a rupee.

In utility analysis it is assume that marginal utility of money (MUm)  is constant.

                                            MUx / Px = MUm

                                            MUx = Price

Units of X MUx

      1 20

      2 18

      3 16

      4 10

      5 0

      6 -5

2. TWO COMMODITY CASE :

When Consumer wants to buy two commodities, his equilibrium will be determined in accordance with the law of equi marginal utility.

                                         MUx/Px = MUy/P     

   Or                         

                                         MUx/Px = MUy/P  = MUm

Let : income (M) = ₹ 6    &   Px = Py = ₹ 1

Units MUx MUy

1 14 10

2 12 8

3 10 6

4 8 4

5 6 2

6 4 0

CONSUMER'S EQUILIBRIUM  : INDIFFERENCE CURVE ANALYSIS

INDIFFERENCE curve shows different combinations of two commodities between which a consumer is indifferent. Each combination offers him the same level of satisfaction.

Indifference curve is a diagrammatic presentation of an Indifference set.

Indifference Set

It is a set of combinations of two commodities which offer a consumer the same level of satisfaction. So that he is indifferent between these combinations.

Combinations Good-X Good-Y

A 1 15

B 2 10

C 3 6

D 4 4

Indifference map 

Indifference map refers to a set of indifference curve.

Higher indifference curve shows higher level of satisfaction. 

It corresponds to higher level of income of the consumer.

Marginal Rate of Substitution : MRS

Moving along an IC , we find that one good is substituted for the other. 

• MRS : It is the rate at which a consumer is willing to substitute Good-1 for Good-2 . or 

• it is the rate at which a consumer is willing to give up Good-2 for a unit more of Good-1.

                       

                           MRS = ∆Good-2/∆Good-1

Combinations Good-X Good-Y MRS

A 1 15 -

B 2 10 1x : 5y

C 3 6 1x : 4y

D 4 4 1x : 2y

PROPERTIES/FEATURES/ CHARACTERISTICS OF Indifference Curve (IC)

1. Slopes Downward from left to right

It implies that is the consumer increases the Consumption 

of one commodity , he will have to reduce the consumption 

of another commodity so as to remain on the same level of satisfaction.

2. IC are Convex to the origin

It implies that is the consumer substitute X & Y

 the MRS between them goes on diminishing.

3. IC never intersect each other

4. Higher the IC, higher is the level of satisfaction

CONSUMER’S BUDGET : Budget set & Budget line

BUDGET SET : It refers to a attainable combinations of a set of two goods, given prices of goods and income of the consumer.

BUDGET LINE : it is a line showing different possible combinations of two goods which a consumer can buy , given his income and the prices of both commodities.

Anywhere on the budget line a consumer is spending his entire income either on Good-1 or on Good-2 or on both Good-1 and Good-2 .

Example :  Let consumer has a budget (M) = ₹ 60  and  Px = ₹ 2 per unit & Py = ₹ 1 per unit

Good-X Good-Y

0 60

10 40

20 20

30 0

ATTAINABLE (FEASBLE) & NON -ATTAINABLE (NON - FEASIBLE) COMBINATIONS

Feasible or attainable combinations : along the line AB or inside it

Non feasible or non attainable combinations : outside the line AB

Changes in Budget Line/ Budget Set

    Budget line changes due to following two reasons :

• change in price of a single good 

• change in income of the consumer

MONOTONIC PREFERENCES

It means that a rational consumer always prefers more of a commodity as it offers him a higher level of satisfaction.       Or 

if between any two bundles, Consumer prefers the bundle which has more of at least one of the good and no less of the other.

Example :  ( 10 , 12 ) & (10, 15) ,      Consumer always preferred (10, 15)

CONSUMER’S EQUILIBRIUM : Optimal choice of the consumer

It is struck when what he is willing to buy (According to his indifferent set) coincides with what he can buy (According to his budget line /price line).

A consumer is said to be in equilibrium when he gets maximum satisfaction out of his Limited income and he has no tendency to make any change in the existing expenditure.

Conditions of consumer's equilibrium 

• IC and budget line are tangent to each other 

        Slope of IC = Slope of budget line

            MRSxy    =   Px/Py

• IC must be Convex to the origin