Explain the conditions of consumer's equilibrium using indifference curve analysis.
Explain the conditions of consumer's equilibrium using indifference curve analysis.
Consumer's equilibrium refers to a situation when a consumer maximises his satisfaction, spending his given income across different goods and services.
In terms of IC analysis, a consumer attains equilibrium when:
(i) IC and the budget line are tangent to each other, i.e. when the slope of IC equals the price ratio of the goods.
(ii) IC is convex to the origin, at the point of equilibrium.
In fig. AB is the budget or price line. IC1,IC2 and IC3 are indifference curves. A consumer can buy any of the combinations, A, B, C, D and E of good X and good Y shown on the price line AB. He cannot attain any combination on IC3 as it is above the price line AB. He can buy those combinations which are not only on the price line AB but also coincide with the highest indifference curve which is IC2 in this case. Out of A, B, C, D and E combinations, the consumer will be in equilibrium at combination 'E' because at this point, the price line (AB) is tangent to the highest indifference curve IC2. No doubt, the consumer can buy `C' or D' combinations as well but these will not give him maximum satisfaction as they are situated on lower indifference curve IC1. It means that the consumer's equilibrium point is the point of tangency of price line and indifference curve. At equilibrium,
Slope of indifference curve = Slope of budget or price line or MRSXY=PXPY
Also, at point E, IC2 is convex to the origin. Accordingly, equilibrium is stable. In a state of equilibrium, the consumer is buying OL amount of good Y and OM amount of good X. It is here that he is maximising his satisfaction. Any departure from this point would only mean lesser satisfaction.
Consumer's equilibrium refers to a situation when a consumer maximises his satisfaction, spending his given income across different goods and services.
In terms of IC analysis, a consumer attains equilibrium when:
(i) IC and the budget line are tangent to each other, i.e. when the slope of IC equals the price ratio of the goods.
(ii) IC is convex to the origin, at the point of equilibrium.
In fig. AB is the budget or price line. IC1,IC2 and IC3 are indifference curves. A consumer can buy any of the combinations, A, B, C, D and E of good X and good Y shown on the price line AB. He cannot attain any combination on IC3 as it is above the price line AB. He can buy those combinations which are not only on the price line AB but also coincide with the highest indifference curve which is IC2 in this case. Out of A, B, C, D and E combinations, the consumer will be in equilibrium at combination 'E' because at this point, the price line (AB) is tangent to the highest indifference curve IC2. No doubt, the consumer can buy `C' or D' combinations as well but these will not give him maximum satisfaction as they are situated on lower indifference curve IC1. It means that the consumer's equilibrium point is the point of tangency of price line and indifference curve. At equilibrium,
Slope of indifference curve = Slope of budget or price line or MRSXY=PXPY
Also, at point E, IC2 is convex to the origin. Accordingly, equilibrium is stable. In a state of equilibrium, the consumer is buying OL amount of good Y and OM amount of good X. It is here that he is maximising his satisfaction. Any departure from this point would only mean lesser satisfaction.
