A consumer consumes only two goods. For the consumer to be in equilibrium why must marginal rate of substitution be equal to the ratio of prices of the two goods? Explain.
OR
A consumer consumes only two goods. Why is the consumer in equilibrium when he buys only that combination of the two goods that is shown at the point of tangency of the budget line with an indifference curve? Explain.
Explain when a consumer, consuming only two commodities X and Y, attains equilibrium under the utility approach.
A consumer consumes only two goods. For the consumer to be in equilibrium why must marginal rate of substitution be equal to the ratio of prices of the two goods? Explain.
OR
A consumer consumes only two goods. Why is the consumer in equilibrium when he buys only that combination of the two goods that is shown at the point of tangency of the budget line with an indifference curve? Explain.
Explain when a consumer, consuming only two commodities X and Y, attains equilibrium under the utility approach.
Let the two goods be X and Y. MRSxy is the number of units of Y the consumer is willing to sacrifice to obtain one extra unit of X. The ratio of prices is Px/Py which also equals the ratio of the number of units of Y required to be sacrificed to obtain one extra unit of X in the market.
Initially when the consumer starts purchases, MRSxy is greater than Px/Py. It means that to obtain one extra unit of X the consumer is willing to sacrifice more than he has to sacrifice actually. The consumer gains. As he goes on obtaining more and more units of X, marginal utility of X goes on declining. Therefore the consumer is willing to sacrifice less and less of Y each time he obtains one extra unit of X. As a result MRSxy falls and ultimately becomes equal to Px/Py at some combination of X adn Y. At this combination the consumer is in equilibrium.
If the consumer attempts to obtain more units of X beyound the equilibrium level, MRSxy will become less than Px/Py and his total utility will start falling.
So he will not try to obtain more of X.
OR
Let the two goods be X and Y as shown in the diagram. The tangency is at point E where :
Slope of indifference curve = Slope of budget line
Or MRSxy = Px/Py,
The equilibrium purchase is Ox of X and Oy of Y on the indifference curve I2. The consumer cannot get satisfaction level higher than I2 became his income does not permit him to move above the budget line AB. The consumer will not like to purchase any other bundle on the budget line AB, for example the bundle at C and D, because they all lie on the lower indifference curve, and give him lower satisfaction. Therefore, the equilibrium choice is only at the tangency point E.
1) Ratio of marginal utility to price in case of expenditure on each commodity is the same i.e.
MUxPx=MUyPy
If MUxPx is greater than MUyPy, the consumer will buy more units of X by diverting expenditures MUy. It will lead to fall in MUx and rise in MUy.
The change will continue till MUx/Px is equal to MUx/Py once again.
The change will be in the opposite direction if MUxPx is less than MUyPy till the equilibrium is achieved.
2) Marginal utility falls as more is consumed i.e. the law of diminishing marginal utility is in operation. The first condition will not be satisfied until the second is satisfied.
Let the two goods be X and Y. MRSxy is the number of units of Y the consumer is willing to sacrifice to obtain one extra unit of X. The ratio of prices is Px/Py which also equals the ratio of the number of units of Y required to be sacrificed to obtain one extra unit of X in the market.
Initially when the consumer starts purchases, MRSxy is greater than Px/Py. It means that to obtain one extra unit of X the consumer is willing to sacrifice more than he has to sacrifice actually. The consumer gains. As he goes on obtaining more and more units of X, marginal utility of X goes on declining. Therefore the consumer is willing to sacrifice less and less of Y each time he obtains one extra unit of X. As a result MRSxy falls and ultimately becomes equal to Px/Py at some combination of X adn Y. At this combination the consumer is in equilibrium.
If the consumer attempts to obtain more units of X beyound the equilibrium level, MRSxy will become less than Px/Py and his total utility will start falling.
So he will not try to obtain more of X.
OR
Let the two goods be X and Y as shown in the diagram. The tangency is at point E where :
Slope of indifference curve = Slope of budget line
Or MRSxy = Px/Py,
The equilibrium purchase is Ox of X and Oy of Y on the indifference curve I2. The consumer cannot get satisfaction level higher than I2 became his income does not permit him to move above the budget line AB. The consumer will not like to purchase any other bundle on the budget line AB, for example the bundle at C and D, because they all lie on the lower indifference curve, and give him lower satisfaction. Therefore, the equilibrium choice is only at the tangency point E.
1) Ratio of marginal utility to price in case of expenditure on each commodity is the same i.e.
MUxPx=MUyPy
If MUxPx is greater than MUyPy, the consumer will buy more units of X by diverting expenditures MUy. It will lead to fall in MUx and rise in MUy.
The change will continue till MUx/Px is equal to MUx/Py once again.
The change will be in the opposite direction if MUxPx is less than MUyPy till the equilibrium is achieved.
2) Marginal utility falls as more is consumed i.e. the law of diminishing marginal utility is in operation. The first condition will not be satisfied until the second is satisfied.
