Consumer’s equilibrium and utility analysis.pptx

Consumer’s equilibrium and utility analysis.pptx

1. Consumer’s equilibrium and utility analysis Anoop Saini

2. Consumer's Equilibrium means  a state of maximum satisfaction . A situation where a consumer spends his given income purchasing one or more commodities so that he gets maximum satisfaction and has no urge to change this level of consumption, given the prices of commodities, is known as the consumer's equilibrium. Conditions of Consumer’s Equilibrium: Consumer utility approach can be understood by two ways: Cardinal Approach (Utility analysis): According to this approach utility can be measured. “Utils” is the unit of utility. Ordinal approach (Indifference Curve Analysis): According to this approach utility cannot be measured but can be expressed in order or ranking.

3. Meaning of utility: Utility: Utility is the power or capacity of a commodity to satisfy human wants. Alternatively, utility of a commodity means the amount of satisfaction that a person gets from consumption of a good or service. Examples: Book for reading & Car for driving

4. Measurement of utility: Two types of utility are there: Cardinal utility Ordinal utility Cardinal utility: It states that the satisfaction the consumer derives by consuming goods and services can be measured with a number . Cardinal utility is a quantitative method that is used to measure consumption satisfaction.

5. Ordinal utility: It states that the satisfaction the consumer derives from the consumption of goods and services cannot be measured in numbers . ordinal utility uses a ranking system in which a rank is provided to the satisfaction that is derived from consumption. ordinal utility is a qualitative method that is used to measure consumption satisfaction.

6. Total utility (TU) and marginal utility (MU): Total utility: it is the sum total of utility derived from the consumption of all the units of a commodity. For example , if 2 units of a commodity are consumed and 1 st units gives satisfaction of 10 units, while the 2 nd unit gives you satisfaction od 9. so the total utility here would be 10+9= 19 utils (units of utility). Marginal utility: it refers to additional utility on account of the consumption of an additional units of a commodity. For example, If 10 units of a commodity give satisfaction of 100 utils , and 11 units of a commodity give satisfaction of 105 utils , then additional utility is 5 utils . (105-100=5)

7. RELATIONSHIP B/W TOTAL UTILITY ( tu ) & MARGINAL UTILITY (mu) QUANTITY TOTAL UTILITY MARGINAL UTILITY 1 10 10 INITIAL UTILITY 2 18 18-10=8 3 24 24-18=6 POSITIVE 4 28 28-24=4 5 30 30-28=2 6 30 30-30=0 ZERO 7 28 28-30=-2 NEGATIVE

8. LAW OF DIMINISHING MARGINAL UTLITY Meaning: The law of diminishing marginal utility states that, “as a consumer consumes more and more units of a specific commodity, utility from the successive units goes on diminishing” . “Also known as Gossen’s first law”.

9. Assumptions of the Law:- assumptions are – Various units of goods are homogenous. There is no time gap between consumption of the different units. Consumer is rational Tastes, preferences, and fashion remain unchanged. Consumers posses perfect knowledge of the price in the market No price change Utilities of different commodities are independent of each other

10. Explanation of the Law: Suppose a person is thirsty and the price of water is zero. He takes one glass of water which gives him great satisfaction. We can say the first glass of water has great utility for him. He then takes second glass of water. The utility of the second glass of water is less than that of first glass of water. The utility declines because the edge of his thirst has been blunted to a great extent. If he drinks third glass of water, the utility of the third glass will be less than that of second and so on. It is the position of consumer’s equilibrium or maximum satisfaction. If the consumer is forced further to take a glass of water, it leads to disutility causing total utility-to decline. The marginal utility will become negative.

11. The following table will make the law of diminishing marginal utility more clear. Units Total Utility Marginal Utility 1 st glass 20 20 2 nd glass 32 12 3 rd glass 40 8 4 th glass 42 2 5 th glass 42 6 th glass 39 – 3

12. The graph will make the law of diminishing marginal utility more clea R

13. LIMITATIONS OR EXCEPTIONS OF THIS LAW Not applicable in case of intoxicants or liquor. Not applicable for misers. Rare collections. Utility is subjective. Every commodity is not an independent commodity.

14. INDIFFERENCE CURVE ANALYSIS ANOOP SAINI

15. Definition of 'Indifference Curve' An indifference curve is a graph showing combination of two goods that give the consumer equal satisfaction and utility. Each point on an indifference curve indicates that a consumer is indifferent between the two and all points give him the same utility.

16. ASSUMPTIONS OF IC ANALYSIS  Rational Consumer  Ordinal Utility  Diminishing Marginal Rate of Substitution. .

17. INDIFFERENCE CURVES A(1, 22) B ( 2 , 14 ) C( 3, 10) D ( 4 , 8 ) E(5, 7) Apples 1 2 3 4 5 6 8 6 4 2 24 22 20 18 16 14 12 10 INDIFFERENCE SCHEDULE (Table Showing Different Combinations giving Equal Satisfaction) Combination Apples Oranges O r a ng e s A 1 22 B 2 14 C 3 10 D E 4 5 8 7

18. INDIFFERENCE CURVES NDIFFERENCE SCHEDULE Combination Apples Oranges A B 1 2 22 14 C 3 10 D E 4 5 8 7 8 6 4 2 1 2 3 4 5 A(1, 22) B (2,1 4) C (3, 1 0) 24 22 20 18 16 14 12 10 D ( 4 , 8 ) E(5, 7) O r ang e s IC 1 Apples

19. MARGINAL RATE OF SUBSTITUTION (MRS) M R S xy Increase in the Consumption of X The marginal rate of substitution of X for Y (MRS xy ) is defined as the amount of Y, the consumer is just w i l l i n g to gi v e u p to g e t on e m o r e uni t o f X and maintain the same level of satisfaction. = Decrease in the Consumption of Y = ∆ Y ∆ X

20. LAW OF DIMINISHING MRS MRS is measured by the slope of the indifference curve MRS = -  O/  A = 8:1 1 2 1 8 6 4 2 1 2 3 4 5 A B C 24 22 20 18 16 14 D E O r an g e s IC 1 Apples MRS = 2:1 MRS = 4:1

21. BUDGET LINE or BUDGET CONSTRAINTS (What is Attainable) Budget constraints limit an individual’s ability to consume in light of the prices they must pay for various goods and services. Budget line or Price Line : Shows all possible combinations of two goods that the consumer can buy if he spends the whole of his given sum of money on his purchases at the given prices.

22. BUDGET LINE Com Apples binat (@ Rs. 6 ion per unit) Or a n g es @ Rs. 2 Per unit Total bud g et (Rs.)=6xA +2xO A 12 2 4 B 1 9 2 4 C 2 6 2 4 D 3 3 2 4 E 4 2 4 Budget line corresponding to budget of Rs. 24 Un attainab le Attain abl e

23. CONSUMER EQUILIBRIUM Consumers choose a combination of goods that will maximize the satisfaction they can achieve, given the limited budget available to them. The maximising combination must satisfy two conditions:  It must be located on the budget line.  Must give the consumer the most preferred combination of goods and services.

24. Thank you………