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Unit 4: Consumer Behaviour (Utility Analysis)




          4.5 The Consumer's Equilibrium with Ordinal Approach                                  Notes

          If we superimpose the indifference map and budget line as in Figure shown above, we find that
          a consumer has to decide to purchase a particular combination (C) as it falls on his budget line,
          though a different combination (D) would be more desirable as it will give a higher level of
          satisfaction. At his point of equilibrium C,  the price line  is touching  the indifference  line
          tangentially meaning that the slopes are equal. The slope of indifference curve indicates the
          marginal rate of substitution between X and Y, and the slope of budget line indicates the ratio of
          price of X to that of Y. Thus the principle of consumer's equilibrium works out; the marginal rate
          of substitution between X and Y must be proportional to the ratio of price of X to that of Y.
                  P
          MRS  =   x
              xy
                  P y
                                            Figure  4.5






















          4.5.1 Changes in Price

          According to the price consumption curve, if the price of X falls, the new budget or price line
          becomes M-L , as more of X can be brought out of the given budget and thus C  becomes the new
                     1
                                                                        1
          equilibrium point. If the price of X falls again, the price of Y and budget remaining same, the
                                     11
          new equilibrium point shifts to C . The line connecting such successive equilibrium points at C,
          C  and C  is called PCC or price consumption curve.
           1
                 11
                                            Figure  4.6























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