What is Consumer Equilibrium?
Equilibrium in economics refers to a point or position that offers maximum benefits in a given situation. Similarly, a consumer is said to be in equilibrium when they don’t want to change the current level of consumption. Or, we can say consumer equilibrium is a point at which a consumer gets maximum satisfaction from the commodities, given their income and prices of commodities remain unchanged.
Consumer Equilibrium is a very popular economics concept. This is because it helps to explain how consumers maximize their utility by consuming one or more commodities. Moreover, it also assists consumers in ranking the combination of two or more commodities on the basis of their taste and preference.
- What is Consumer Equilibrium?
- Understanding Consumer Equilibrium
- Consumer Equilibrium: When Consumer Spend all Income on a Single Commodity
- Example of Single Commodity
- Consumer Equilibrium: When Consumer Spend all Income on Two or More Commodities
- Example of Two or More Commodities
- Final Words
Understanding Consumer Equilibrium
In simple words, a consumer is in equilibrium if he believes that he won’t be able to change his situation either by making more money or increasing the expenditure, or altering the quantity of commodities that he buys.
A rational consumer will buy a commodity to the point where the price of the commodity equals the marginal utility (MU) from it. Until such a condition is met, the consumer will buy more or less of the commodity.
In case the consumer buys more, the marginal utility will drop. And it would lead to a situation when a consumer pays a higher price than the MU. The consumer will have to lower consumption to overcome such a situation (negative utility or dissatisfaction). This will lead to a rise in MU. The consumer will continue to reduce consumption until the price equals the marginal utility.
If the MU is more, it would mean that the consumer got additional satisfaction from the unit he consumed earlier. Thus, the consumer would have to consume more of the commodity until the MU reduces and equals the price.
So, we can say that by adjusting the purchase of a commodity, a consumer will be able to reach equilibrium. Adjusting the purchase will get consumers to a point where the consumer’s total utility is maximum, and the price equals the MU.
We can further explain equilibrium under two different situations. These are when a consumer spends all income on a single commodity and when a consumer spends all income on two commodities.
Consumer Equilibrium: When Consumer Spend all Income on a Single Commodity
To explain this concept, we need to make the following assumptions:
- Consumer buys only one commodity.
- The price of the commodity is fixed. And the consumer only needs to decide the quantity they need to buy at that price.
- Consumer acts rationally to maximize the total level of satisfaction.
- The consumer has enough money to purchase as many units as he wants of the commodity at the given price.
Law of Diminishing Marginal Utility
We can use the law of diminishing marginal utility to explain the equilibrium in the case of a single commodity. This law states that as a consumer consumes more quantity of a commodity, the marginal utility from each additional quantity reduces.
In this case, the consumer uses two factors to determine the quantity that he would buy. These two factors are the price of each unit of the commodity and the utility that a consumer gets. This means when deciding on buying a unit of a commodity, a consumer compares the commodity’s price with the utility.
In this case, the consumer will be at equilibrium when the MU (in money terms) is equal to the price of the commodity. If the commodity is ‘X,’ then the equilibrium will be MUx = Px. Px here is the price of the commodity.
When the MUx is more than the price, the consumer will go on purchasing the commodity. This is because the consumer is paying less for the additional satisfaction. As a consumer purchases more units, it would lead to a drop in MU. The consumer will continue to buy more units until he reaches a state of equilibrium, where MUx = Px.
In a scenario where the MUx is less than the price, the consumer will need to reduce consumption so as to increase the satisfaction level. The reduction in consumption will continue until MUx equals the price.
Example of Single Commodity
Let’s take an example to understand the concept better.
Suppose Mr. A wants to buy a commodity that has a price of $10. To make it simple, we are assuming that one MU equals $1.
|Units Consumed||MUx||Price per unit||MUx (Monetary terms: MUx/$1)||Difference|
When the quantity consumed is 1 and MUx is 20, then MUx in money terms will be $20 (20 * $1). The difference, in this case, will be $10, or we can say MUx is more than the price (the price, in this case, is $10 as there is only one unit).
So, to reach equilibrium, the consumer will increase their consumption. When the consumption rises to 2 units, the difference reduces to 6. And, when the consumption is 3 units, the difference is zero. So, at 3 units, MUx equals the price, which is the equilibrium point.
Now, suppose Mr. A continues to increase consumption beyond three units. This will result in a drop in MUx. To reach equilibrium, Mr. A will now have to reduce consumption.
Consumer Equilibrium: When Consumer Spend all Income on Two or More Commodities
The law of diminishing marginal utility doesn’t hold when there are two or more commodities. Instead, we use the law of equi-marginal utility to find out how a consumer allocates the income optimally. As per this law, the consumer should use his income to buy commodities in such a way that the last dollar spent on each commodity gives the consumer equal marginal utility so as to get maximum satisfaction.
Further, as per this law, a consumer is at equilibrium when the ratio of MU and the price of one commodity is the same as the ratio of MU and the price of other commodities.
For instance, if there are two commodities (a and b), then the equilibrium will be: (MUa/Pa) = (MUb/Pb).
A point to note is that MU/P is basically the Utility in monetary terms, or the MU of the last dollar spent.
Example of Two or More Commodities
Let’s take an example to get a better understanding:
Mr. A has an income of $5 that he needs to use to buy two commodities X and Y. The price of both commodities is $1 each. It means, Mr. A can buy a maximum of five units of each commodity. The table below shows the marginal utility for Mr. A after consuming various units of both commodities.
From the above table, we can get that Mr. A will first buy one unit of X as it will give 20 utility. Then he will buy one unit of Y as it gives him 16 utility.
In this case, the equilibrium will be when Mr. A consumes 3 units of X and 2 units of Y.
MUx/Px at 3 units is 12, while MUy/Py at 2 units is 12.
With this combination, Mr. A will be able to use all his income (With $5, Mr. A can buy 3 units of X and 2 units of Y).
So, now we can say that consumer equilibrium is a point at which a consumer gets maximum satisfaction from consuming certain units of one or more commodities. This economic concept is simple to understand. Thus, economists and educational institutions use it widely to explain how a consumer makes choices.
- Law of Equi Marginal Utility – Meaning, Assumptions, and Importance
- Total Utility – Meaning, Importance, and Example
- Law of Diminishing Marginal Utility
- Marginal Utility – Meaning, Importance, Factors, Types, and Graph
- Marginal Benefit – Meaning, Importance And More
- Indifference Curve – Meaning, Features, Example, and Graph