Consumer Equilibrium
Consumer Equilibrium (Demand Analysis)
A consumer is said to be in equilibrium, when he maximizes his utility, in other words he spends his money income in such a way that the utility derived from the last rupee spent on each good is equal.
MUx = MUy = ……….. = MUMONEY
Px Py
Consumer Equilibrium (Indifference Curve Analysis)
(Two commodity model)
In a two commodity analysis or IC analysis, a consumer achieves equilibrium by moving along the budget line till he reaches a point where the budget line is tangent to the indifference curve. Which means Marginal rate of substitution of two commodities becomes equal to the ratio of their prices
MUx = Px
MUy Py
An indifference curve (located on a graph) is a curve which shows the relative happiness between an individual, and purchasing two items (consumer goods). An indifference curve has infinite possibilities as it is not limited by the amount of income (budget line). When combined with a budget line, the highest intersecting point between the two creates your optimal consumption point (where your happiness is at the highest possibility with those two products).
The graph above shows the relation between a budget line and the infinite possibilities of indifference curves. Remember, indifference curves are infinite because they are indicated by what one person is willing to buy, not able to buy.
The black angled line indicates the budget line, the affordability between the two items. The red convex lines indicate the many possible indifference curves created by an individual. The two indifference curves located below the budget line allow us to buy the products, but not at our highest marginal utility. The highest indifference curve will give us our highest marginal utility, but it is out of our affordable range. The second indifference curve from the top which intersects with our budget line gives us our highest marginal utility within our affordable rate, which means it is our optimal consumption point.