State the conditions of consumer's equilibrium in the indifference curve analysis and explain the rationale behind these conditions.
State the conditions of consumer's equilibrium in the indifference curve analysis and explain the rationale behind these conditions.
Conditions of consumer's equilibrium using indifference curve analysis are
(i) MRS =PXPY, and
(ii) IC is convex at the point of equilibrium.
Rationale of condition 1: In case MRS>PXPY, it shows that the consumer is willing to sacrifice more of good Y (for a unit of good X) than what he needs to sacrifice given the market price of X and Y, as his welfare is not presently maximised.
In case MRS<PXPY, it shows that the consumer is willing to sacrifice less of good Y (for a unit of good X) than what he must do, given the market price of X and Y. He must shift from this position to be in a state of equilibrium because the market does not allow it.
Rationale of condition 2: In case MRS is not convex to the origin at the point of equilibrium, it shows that MRS is not diminishing. Diminishing MRS points to the application of the law of diminishing marginal utility. If MRS is not diminishing, it means that the law of diminishing marginal utility is violated and the consumer will not stop the consumption of one good as every additional unit would yield him more and more satisfaction. The equilibrium cannot be attained.
Conditions of consumer's equilibrium using indifference curve analysis are
(i) MRS =PXPY, and
(ii) IC is convex at the point of equilibrium.
Rationale of condition 1: In case MRS>PXPY, it shows that the consumer is willing to sacrifice more of good Y (for a unit of good X) than what he needs to sacrifice given the market price of X and Y, as his welfare is not presently maximised.
In case MRS<PXPY, it shows that the consumer is willing to sacrifice less of good Y (for a unit of good X) than what he must do, given the market price of X and Y. He must shift from this position to be in a state of equilibrium because the market does not allow it.
Rationale of condition 2: In case MRS is not convex to the origin at the point of equilibrium, it shows that MRS is not diminishing. Diminishing MRS points to the application of the law of diminishing marginal utility. If MRS is not diminishing, it means that the law of diminishing marginal utility is violated and the consumer will not stop the consumption of one good as every additional unit would yield him more and more satisfaction. The equilibrium cannot be attained.
