Consumer Equilibrium and Utility

Overview

This lecture is based on the concepts of Consumer Equilibrium and Utility, their types, related rules, and graphical analysis.

Concept of Consumer and Utility

• A consumer is a person or group who fulfills their desires by purchasing goods or services.
• Utility is the capacity of a good/service to satisfy a desire.
• The unit of measurement for utility is called Utils.

Types of Utility

• Total Utility: The total satisfaction obtained from all units of a good.
• Marginal Utility: The additional satisfaction obtained from consuming one more unit.
• TU = u₁ + u₂ + u₃ + ... ; MU = ΔTU/ΔQ

Law of Diminishing Marginal Utility

• Satisfaction obtained from each additional unit of a good decreases.
• This rule was given by H.H. Gossen; it is also called Gossen's First Law.
• Conditions for the rule to apply: Cardinal measurement, fixed income, constant quality, etc.

Consumer Equilibrium

• Consumer equilibrium is the state where the consumer neither wants more nor less of a good.
• Single commodity case: Equilibrium at MU = Price.
• Dual commodity case: Equilibrium at MUx/Px = MUy/Py.

Ordinal Utility Approach and Indifference Curve

• Ordinal utility: Satisfaction can be ranked but not measured.
• Indifference curve: Combinations of two goods that provide the consumer with the same satisfaction.
• Indifference curves are always convex and never intersect.
• Monotonic preference: More goods, more satisfaction.

Budget Line and Budget Set

• Budget line: Shows how many goods can be purchased given income and prices.
• Budget set: All points inside the budget line where expenditure is less than or equal to income.
• Expression of budget line: PxQx + PyQy = M (M=Income)

Graphical Analysis and Equilibrium Point

• Consumer equilibrium is found at the tangency of the indifference curve and budget line.
• At the equilibrium point, MRS = Px/Py.

Difference Between Cardinal and Ordinal Utility

• Cardinal: Satisfaction is measured by numbers.
• Ordinal: Only ranks are given, not measured.

Key Terms & Definitions

• Utility — The power of a good to satisfy desires.
• Total Utility — Total satisfaction from all units.
• Marginal Utility — Satisfaction from one additional unit.
• Consumer Equilibrium — No tendency to consume more or less.
• Budget Line — Maximum purchase limit of goods according to income.
• Indifference Curve — Combinations of goods giving equal satisfaction.

Action Items / Next Steps

• Draw graphs of indifference curve and budget line for the next class.
• Remember the conditions of the law of diminishing marginal utility.
• Write the differences between ordinal and cardinal utility.