Consumer’s equilibrium refers
to when consumer gets maximum satisfaction from his money income and prices of
goods he is willing to buy. For instance, suppose, a consumer who is consuming
good X and Y. Consider the prices of these two goods don’t change and the
consumer has fixed income. Now the consumer will purchase the quantities of
these two goods. When he gets maximum satisfaction from these two goods he will
be at the point of equilibrium.
Graphically, consumer is said
to be equilibrium at a point where his budget line touches the highest
indifference curve. The given below
diagram is illustrating the concept of consumer’s equilibrium.
In the above figure 1.1, BL is the budget line of the consumer.
It can be seen there is a set of three indifference curves IC1, IC2 and IC3. We can see budget line is touching
the highest indifference curve IC3
at point E. Point E
is the consumer’s equilibrium, because at this point consumer is getting
maximum satisfaction by consuming OQ
quantity of good X and OM quantity
of good Y.
Consumer’s equilibrium is
based on the assumption that income of the consumer and prices of goods remain
constant. However, the level of consumer’s equilibrium can be changed or moved
due to the following effects
- Income effect
- Substitution effect
- Price effect
Consumer’s Equilibrium Under Income Effect
Income is one of the most
influential factors affecting purchase of goods significantly. If the prices of
goods remain unchanged while there is a change in money-income, it will affect
consumer’s demand. This effect on
consumer’s demand due to change in income is referred to income effect.
A rise in income of the
consumer enables him to buy more both goods (X and Y). His budget line shifts
upward to the right and his level of satisfaction moves to higher point of
equilibrium. Inversely, when income of
the consumer decreases, his budget line shifts to inward to the left. The
budget lines are parallel to each other as prices of the goods are assumed to
remain constant. The given below diagram
is illustrating income effect.
In the above graph 1.2 there
are three equilibrium points E1, E2 and E3 located on three indifference curves IC1, IC2 and IC3. AB is the initial budget line which yields consumer E1 which is initial equilibrium point.
When his income increases while prices of goods remain constant, his budget
line shift from AB to CD and his equilibrium point also moves
from point E1 to point E2. We can see when the income of
consumer further increases, his budget line shifts from CD to FG and his
equilibrium point also moves from point E2
to point E3. If these equilibrium
points are joined together, we get income consumption curve ICC. This ICC curve
represents income effect.
Consumer’s Equilibrium Under Substitution Effect
When the price of one
commodity falls out of two commodities, it becomes comparatively cheaper than
another commodity which price increases, the consumer substitutes the cheaper
commodity for another commodity which is now relatively costly.
Suppose, a consumer who has
fixed income. He purchases X and Y commodity. Now assume the price of X
commodity falls and the price of Y commodity increases. What will he do in this
situation? He will tend to buy more quantity of X commodity and less
quantity of Y commodity in order to maintain same level of satisfaction. What
is he actually doing? He is substituting X commodity for Y commodity. This
behavior of consumer representing substitution effect. The given below figure is illustrating the
concept of substitution effect.
In the above figure 1.3, AB is the initial budget line of the
consumer. Point R is the initial
equilibrium point located at indifference curve IC. At point R consumer
is obtaining ON quantity of
commodity X and OF quantity
commodity Y. When the price of commodity
X falls and the price of commodity Y rises, the budget line of the consumer shifts from AB to AD and consumer moves to new equilibrium point S which is located at the same indifference curve IC. This movement of equilibrium points from R to S at same indifference curve is representing the substitution
effect. At point S, the consumer
increased quantity of X commodity from ON
to OM and decreased quantity of Y
commodity from OF to OK in order to maintain same level of
satisfaction.
Consumer’s Equilibrium Under Price Effect
Price effect is the quantity
demanded changes due to change in price of one commodity while income of the
consumer and price of other commodity remain constant. Suppose, there are two
commodities X and Y. The price of X falls while income of the consumer and the
price of Y remain constant. In this case, the consumer will buy more quantity
of X as it is relatively cheaper than Y.
Given below graph is explaining price effect.
In the above diagram 1.4, E1 is the initial equilibrium point of
the consumer located indifference IC1.
When the price of commodity X falls, the
consumer increases quantity of X commodity from Q1 to Q2 while maintain
the quantity of Y commodity. By
increasing quantity of X commodity, the consumer’s budget line shifts from AB to AC and his equilibrium point moves from E1 to E2 located IC2. When the price of X commodity further
decreases, the consumer’s budget line shifts from AC to AD and his equilibrium
point moves from E2 to E3 located IC3. If we join the equilibrium points from E1 to E3, we will get PCC curve. The PCC curve is showing price effect.
IT is the best explenation!!! thANKS A LOT
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