Consumers Equilibrium

Question 1

Meaning and objective of a consumer?

Answer 1

A consumer is an economic agent who consumes or purchases goods or services to satisfy his/her wants.
The satisfaction of wants is the beginning and end of all economic activities.
The objective of a consumer is to get maximum satisfaction from the expenditure incurred on a commodity.

Question 2

What is utility?

Answer 2

It is the want satisfying power of a commodity. It refers to the amount of satisfaction received after consumption of a commodity.

Question 3

What are the characteristics of utility?

Answer 3

1. Utility depends on urgency and intensity of want: More intensity implies higher utility. Ex: a pen has more utility during exams than in summer vacation
2. Utility is subjective: A commodity doesn’t have a fixed utility as utility keeps changing in time and place. The same consumer may derive higher or lower utility from the same commodity depending on on the time and place
3. Utility is measurable: Cardinal and ordinal utility
4. Utility is not essentially useful: higher utility doesn’t mean greater usefulness, drugs have high utility but aren’t useful

Question 4

What are the measure of utility?

Answer 4

1. Cardinal Utility: Given my Marshal. Measures utility in a quantity. The units of utility are called utils. Measured in absolute numbers. Marginal utility curve is used to explain consumer equilibrium.
2. Ordinal Utility: Given by hicks and allen. Measure utility in a qualitative, ranking order. It is measured in ranks. Indifference curve is used to explain consumer equilibrium.

Question 5

What are the concepts of utility?

Answer 5

1. Total Utility - Total phycological satisfaction a consumer gets from a certain amount of a commodity. Denoted by TU
2. Marginal utility - it is an addition made to total utility by consuming an additional unit of that commodity. Denoted by MU.
   MU = Total TU/Total quantity

Question 6

What is the law of diminishing marginal utility?

Answer 6

Given by german economist Gossen. Known as gossens first law of consumption.
Law states that as the stock of goods for consumption increases, the utility decreases. The more u consume, the less satisfying it becomes each time.

Question 7

What is the relationship between TU and MU?

Answer 7

1. As long as MU is positive, TU increases
2. When MU is zero, TU maximum and constant (Point of saturation/satisfaction)
3. When MU is negative, TU decreases
4. TU is the summation of MU, and MU can be derived from TU
5. MU is the slope of the TU curve

Question 8

Exceptions to law of DMU

Answer 8

1. Drunkards
2. Hobbies
3. Misers
4. Music and poetry
5. Reading

Question 9

Meaning of Consumers equilibrium

Answer 9

refers to a situation where the consumer spends his income on a commodity in such a way that it gives him maximum satisfaction.

Question 10

conditions for Consumers equilibrium in case of single commodity

Answer 10

1. MUx = Px
2. Total gain falls after equilibrium
3. Law of DMU takes place

Question 11

What happens when Prior to equilibrium in case of single commodity

Answer 11

Prior to equilibrium, MUx > Px, thus a rational consumer consumes more units of the commodity as he revieces more satisfaction than price payed. Law of DMU operates, and the MUx decreases, until MUx = Px and the consumer reaches equilibrium.

Question 12

What happens after consumers equilibrium in case of single commodity?

Answer 12

After consumers equilibrium MUx < Px, since he recieves less satisfaction than the sacrifice made in terms of money, a rational consumer stops consuming units of the commodity. Law of DMU operates in opposite direction and once again MUx = Px or MUx>x

Question 13

What is MU in money terms/Rupees

Answer 13

MU of a util/MU of a rupee

Question 14

What are the conditions for consumers equilibrium in case of two commodities?

Answer 14

1. MUx/Px = MUy/Py
2. Law of DMU operates
3. Expenditure = Money income

Question 15

If MUx/Px > MUy/Py in case of consumer equilibrium of two commodities what happens?

Answer 15

If MUx/Px > MUy/Py, it means that the consumer gains more satisfaction consuming commodity x, right now compared to y. Therefore he will consume more units of x or lesser units of y. Law of DMU takes place and he reaches equilibrium

Question 16

What is consumption bundle?

Answer 16

Combination of quantities of two goods

Question 17

Budget set

Answer 17

All consumption bundles a consumer can buy with his money income and market prices.

Question 18

What is budget line

Answer 18

A line representing different bundles that the consumer can purchase spending his entire money at given prices.

Question 19

What are the features of Budget line?

Answer 19

1. It is a straight line
2. It is downward sloping or negative sloping
3. Slope of budget line is equal to price ratio of two goods. Slope of budget line = (-) P1/P2
4. It make intercepts or cuts x and y axis and consumer can consume 0 units of one commodity.

Question 20

What factors does budget line depend on?

Answer 20

1. Px
2. Py
3. Money income of consumer

Question 21

What happens to budget line when there is a change in income

Answer 21

If income increases, budget line moves rightward, it income decreases, budget line moves leftward

Question 22

What happens to budget line if there is a change in price of only one good

Answer 22

There is a pivotal shift in budget line. An increase in price leads to lesser units of commodity consumed.

Question 23

What happens to budget line of price of good one and good two change in same direction and by same percentage

Answer 23

If prices increases there will be a parallel leftward shift and if prices decrease there will be a parallel rightward shift

Question 24

When prices of good 1, good 2 and income of consumer change in same direction in same percent/proportion what happens to budget line?

Answer 24

No change

Question 25

If price of one good increases and price of other decreases what happens to budget line?

Answer 25

The new budget line cuts the old one. If commodity x price decrease, its units go up and commodity y price increase its units go down.

Question 26

Indifference curve

Answer 26

It is a combination of various bundles of goods that give equal level of satisfaction to the consumer, hence the consumer is indifferent between the bundles.

Question 27

Assumptions for indifference curve analysis.

Answer 27

1. Diminishing MRS 2. Consumer spends on two goods given constant prices of both 3. Consumer can rank his preferences on basis of satisfaction of goods 4. Consumer aims to maximize satisfaction

Question 28

MRS

Answer 28

MRS of marginal rate of substitution is the slope of the indifference curve. MRS is the rate of sacrifice. MRS = Loss/gain Curve of IC graph is convex to origin due to diminishing MRS

Question 29

Properties of IC curve.

Answer 29

1. Slopes downward: To gain units of X, units of Y have to sacrificed as same level of satisfaction has to be met 2. Convex to origin - To get extra units of X, we sacrifice less and less of Y. Due to diminishing MRS to is convex 3. Higher IC represents higher level of satisfaction (monotonic preference - consumer will always prefer maximum number of total goods) 4. Indifference curves don't cut each other - A IC curve shows points that give same satisfaction. If two IC curves cut, two different points and IC curves will give same satisfaction 5. IC curve never touches x or y axis - Based on ordinal utility analysis which always requires two goods

Question 30

Indifference map

Answer 30

Set of IC curves

Question 31

Consumers equilibrium with IC curve.

Answer 31

Shows that the consumer wants to buy (represented by IC curve), and what the consumer can buy (shown by budget line).

Question 32

Conditions to determine consumers equilibrium with ordinal utility analysis?

Answer 32

1. Budget line should be tangent to IC curve 2. Slope of IC = slope of BL (MRE = MRS or px/py = Loss/gain) 3. IC line should be convex to origin

Question 33

Equation for budget line?

Answer 33

P1X1 + P2X2 = Money income

Question 34

Budget Constraint

Answer 34

Limit to the consumers expenditure. Represented to by the budget line. Shows Limit on the bundles that the consumer can afford.