Explain the Consumers Equilibrium with the Help of Indifference Curve Analysis.
Every consumer aims at a spending his income in a way that gives him maximum satisfaction. When a consumer gets maximum satisfaction from his expenditure, he is said to be in equilibrium consumer’s equilibrium means maximum satisfaction level consumer can attain at given income and prices. We can explain the equilibrium of consumer with the help of the indifference curve technique.
The point of interest here is the choice of that combination of two goods which give the consumer maximum satisfaction. To find out this we require the following information about the consumer.
- Consumer’s Income
- Prices of two goods
- Preference schedule.
On the basis of (i) and (ii), i.e. income and price, we can get Budget line. The (iii), i.e. the preference schedule, is the same as in Indifference map. According to Hibbdon, “The budget line is that line which shows all the different combinations of the two commodities that a consumer can purchase given his money income and the price of two commodities.” Indifference map is that graph which represents a group of indifference curves each of which expresses a given level of satisfaction.
Given the information we need, there are two condition of equilibrium.
Suppose, the two goods are X and Y and shown on the X and Y axis respectively. We can write the above condition as follow :
MRSYK = PX : PY
MRSYX is the slop of indifference curve.
PX/PY is the slop of budget line.
So, we can also write the above condition as follows:
Slope of indifference curve = Slope of budget line.
The two slopes would be equal when budget line is tangent to indifference curve.
MRS Declines as one Goods is Substituted for Another or the indifference curve is convex to the origin.
When MRSyx is not equal to Px / Py , unless MRSys is declining,, the reallocation of income by the consumer will not make MRSyx = Px / Pr. Its clear from the explanation of the first condition. It means that if indifference curve is not convex, but is of any other shape, the equilibrium cannot be achieved.
The condition of MRSyx = Px/Py is achieved at the point of tangency of budget line (AB) and indifference curve, i.e. at point E (see figure). It is to be noted that a consumer must remain somewhere on the budget line when he is equilibrium. He cannot move above the budget line because his income does not permit him. Moreover, he will not stand below the budget line because there is an assumptions that the entire income is spent on two goods. So, the equilibrium must be some where in the budget line.