Question

Given the market price of a good, how does a consumer decide as to how many units of that good to buy? Explain.

Answer 1

A consumer is in a state of equilibrium when he maximizes his satisfaction by spending his given income on different goods and services. Any deviation or change in the allocation of income under the given circumstance will lead to a fall in total satisfaction.

For one-commodity case: Rupee worth of satisfaction actually received by the consumer is equal to the marginal utility of money as specified by the consumer himself.

Condition 1 : MU(of good X) = MU(of money) OR , PRICE(of good X) = MU(of money)

Reason: Price paid by the consumers should be exactly equal to the money value of MU that he derives. In case P(of X) is lesser than the MU(of money), he should be prompted to buy more of good X. Higher consumption will lead to a fall in MU. The consumption of good X would stop only when P(of good X) will be equal to MU(in terms of money). Likewise, if P(of X) is greater than MU(in terms of money), the consumer will be prompted to buy less of good X, leading to a fall in MU.

Condition 2: Marginal utility of money remains constant.

Condition 3: Law of marginal utility holds good.

For two-commodity case: Rupee worth of marginal utility of money should be same across good X and good Y, and equal to marginal utility of money.

Reason: In case rupee worth of satisfaction (MU of good X/ price of good X) is greater for good X than good Y, the consumer will be prompted to buy more of good X and less of good Y. This would lead to a fall in marginal utility of good X and a rise in marginal utility of good Y. This process would continue till MU(of good X)/ Price of good X = MU(OF GOOD Y)/ Price of good Y = MU(of money) . In case rupee worth of satisfaction (MU of good y/ price of good Y) is greater for good Y than good X, the consumer will be prompted to buy more of good Y and less of good X. This would lead to a fall in marginal utility of good Y and a rise in marginal utility of good X.