CBSE Class XI Micro Economics

1. CONSUMER’S
EQUILIBRIUM

2. 1.Utility Analysis
2.Indifference Curve Analysis

3. UTILITY ANALYSIS
• TU: Sum total of utility derived from the consumption of all the units of
a commodity.
• MU: Additional utility derived from the consumption of an additional
unit of a commodity.
TU = U1 + MU2 + MU3 …
TU = Total Utility
U = Utility
MU = Marginal Utility
• Marginal Utility = Change in total utility / Change in number of units
consumed
• MU=TUn-TUn-1

6. PRACTICE QUESTION
1. The total utility schedule of individual ‘A’ is given
below. Derive his MU Schedule
UNITS CONSUMED TU
0 0
1 15
2 28
3 40
4 51
5 61

7. 2. MU Schedule of individual ‘A’ is given below.
Derive his TU schedule
UNITS CONSUMED MU
1 16
2 15
3 13
4 10
5 6
6 1

8. LAW OF DIMINISHING MARGINAL UTILITY
• It is a fundamental law.
• It states that as more and more units of a commodity are
consumed, MU derived from every additional unit must
decline.
• It happens in respect of all goods and services.
• It is also known as ‘Fundamental Law of Satisfaction’ or
‘Fundamental Psychological Law’

11. Can MU be negative?

12. YES!!!
• It is a situation when consumption of
an additional unit leads to
dissatisfaction instead of satisfaction.
• It creates disutility instead of utility
UNITS
COSUMED MU
1 10
2 8
3 6
4 4
5 2
6 0
7 -2 (Zone of dissatisfaction)

13. MEANING OF CONSUMER’S EQUILIBRIUM
The consumer is in equilibrium when, given his
income and market price, he plans his
expenditure (on different goods and services) in
such a manner that he maximizes his total
satisfaction

14. How much of a commodity a
consumer buys so that he
maximizes his satisfaction and
attains the point of equilibrium?

15. UTILITY ANALYSIS AND CONSUMER’S EQUILIBRIUM
• In case of one commodity
• In case of two or more commodities

16. ASSUMPTIONS
• The utility can be expressed in cardinal number i.e. 1,
2, 3….
• Marginal utility of money remains constant
• The law of DMU holds good
• The consumer behaves rationally and aims at
maximizing his satisfaction

17. ONE COMMODITY CASE
Purchase of a commodity will depend upon 3
factors:
• Price of the commodity (Px)
• Marginal utility of a commodity (Mux)
• Marginal utility of Money (Mum)

18. MARGINAL UTILITY OF MONEY
• It refers to ‘worth of a rupee’ to a consumer.
• A consumer defines it in terms of utility that he derives
from a standard basket of goods that he can but with a
rupee.
• It is assumed to be constant.
• It is a measuring rod for rupee worth of satisfaction.
• It is a subjective concept and differs from person to person

19. EXAMPLE
Let
• Mum = 4 utils (constant)
• Px = 4 Rs.
• Mux is given below
X MU (X)
1 20
2 18
3 16
4 10
5 0
6 -5

20. How many units a consumer
should purchase to be in the
state of equilibrium?

21. Marginal Utility in terms of Money =
Marginal Utility of X in utils /
Marginal Utility of one rupee (MUM)
OR
MU(X) / P (X) = MU (M)

22. X MU (X)
MU in terms of
Rupee
1 20 20/4 = 5
2 18 18/4 = 4.5
3 16 16/4 = 4
4 10 10/4 = 2.5
5 0 0/4 = 0
6 -5 -5/4 = -1.25

23. X MU (X)
MU in terms of
Rupee
1 20 20/4 = 5
2 18 18/4 = 4.5
3 16 16/4 = 4
4 10 10/4 = 2.5
5 0 0/4 = 0
6 -5 -5/4 = -1.25

24. DIAGRAMMATIC ILLUSTRATION

25. OBSERVATIONS
• Equilibrium is struck at point E
• Corresponding to point E, the price that the consumer is willing to pay for a
unit of the commodity exactly matches with the price that he actually pays
• Mux is a downward sloping curve showing that Mux declines as
consumption of X increases
• Px indicates market price of commodity X. It is fixed for the consumer and
is taken to be equal to Rs. 4
• Each point on Mux shows Mux in terms of money i.e. the price consumer is
willing to pay
• So long the price consumer is willing to pay is greater than the price he
actually pays, the consumer makes a gain which is known as consumer
surplus
• In a state of equilibrium, consumer surplus is maximum

26. PRACTICE QUESTION
1. What price the consumer is ready to pay for a commodity in a state of his
equilibrium?
2. Ice cream sells for Rs.20. Priya who likes ice cream, has already consumed
4. her MU of one rupee is 4. Should she consume more ice cream or stop
the consumption?
3. Given below is the utility schedule of commodity X. Px = Rs. 6 Determine
consumer’s equilibrium
UNITS COSUMED TU MU
1 10 10
2 18 8
3 25 7
4 31 6
5 34 3
6 34 0

27. What if..??
MUx / Px ≠ MUm
Mux / Px > MUm Mux / Px < MUm
Gain > Sacrifice Gain < Sacrifice
Consumption Consumption
MU MU

28. TWO (OR MORE) COMMODITY CASE
Suppose there are 2 commodities i.e X and Y
In case of commodity X, equilibrium will be established at
MUx / Px = MUm
In case of commodity Y, equilibrium will be established at
MUy / Py = MUm
Conclusion: MUx / Px = MUy /Py = Mum
Marginal utility per rupee spent on Good X = Marginal utility
per rupee spent on Good Y = Marginal utility of money

29. EXAMPLE
Let MUx = 20, Px = 4, MUy = 25, Py = 5
Is the Consumer in equilibrium, if MUm = 5??
Equilibrium condition
MUx / Px = MUy /Py = Mum
Substituting values
20/4 = 25/5 = 5
5 = 5= 5
Hence, the consumer is in equilibrium

31. UNITS CONSUMED MUx MUy
1 25 30
2 20 26
3 15 15
4 10 2
5 0 0
Let Px = Py = Rs.1 per unit
Income = Rs.6

32. UNITS CONSUMED MUx MUy
1 25 (3) 30 (1)
2 20 (4) 26 (2)
3 15 (5) 15 (6)
4 10 2
5 0 0
Tu = 30+26+25+20+15+15 = 131
3 of X and 3 of Y

33. DIAGRAMMATIC ILLUSTRATION
Equilibrium

34. OBSERVATIONS
• The consumer consumes 3 units of commodity X and 3 units of
commodity Y
• Mux (at 3 units) = Muy (at 3 units)
• Equilibrium is struck at point E, where Mux and Muy line
intersect each other

35. CONCLUSION
• In case of two commodities, equilibrium is struck when
the last rupee spent by consumer yields equal marginal
utility whether he spends it on Good-X or Good –Y
• This is also known as Law of Equi-Marginal Utility or
Gossen’s 2nd law of Consumption

36. What if..??
MUx / Px ≠ MUy / Py
Mux / Px > MUy / Py Mux / Px < MUy / Py
Consumer will shift his
expenditure from Y to X
Fall in Mux
Consumer will shift his
expenditure from X to Y
Fall in MuY
MUx / Px = MUy / Py

37. PRACTICE QUESTION
1. Mr. X consumes two commodities A and B whose prices are Rs.
6 and Rs. 8 per unit respectively. Does Mr. X strikes his
equilibrium when he is getting MU from A = 7 and MU from B
= 7?
2. A Consumer consumes only two goods X and Y. At a
consumption level of these two goods, he finds that the ratio
of Marginal utility to price in case of X is higher than in case of
Y. Explain the reaction of the consumer.

38. INDIFFERENCE
CURVE ANALYSIS

39. Meaning of
Indifference
Unbiased or
Impartial
I can eat
anything….Burger
or Pizza!!!!

40. EXAMPLE
Peter has 1 unit of burger and 12 units of clothing.

41. Peter how many units of clothing
are you willing to give up
in exchange for an additional unit
of burger so that your level of
satisfaction remains unchanged?

42. Peter agrees to give up 6 units of clothing for an
additional unit of burger

43. Hence, we have two combinations of buregr and
clothing giving equal satisfaction to Peter as follows:
1 unit of burger and 12 units of clothing
2 units of burger and 6 units of clothing
Combination Burger Clothing
A 1 12
B 2 6
C 3 4
D 4 3
By asking him similar questions, we get various
combinations as follows:

44. OBSERVATION
• Combination A, B, C and D are specified by Peter according to his
scale of preference for the two commodities
• Each combination offers him the same level of satisfaction. So in
terms of the level of satisfaction, Combination A = Combination
B = Combination C = Combination D
• As there is no difference among these 4 combinations, we may
say that the consumer is indifferent across these combinations.
Together, these combinations form an ‘Indifference Set’ of the
consumer

45. Indifference Set
It is a set of those combination of two goods
which offers the consumer the same level of
satisfaction. So that, the consumer is indifferent
across all combinations in his indifference set

46. DIAGRAMMATIC PRESENTATION

47. Indifference Curve
It is a diagrammatic representation of an
indifference set of a consumer. It is a locus of all
such points which show different combination of
two such commodities offering the same level of
satisfaction to the consumer.
It is also known as Iso-Utility Curve.

48. Indifference Map
An Indifference Map is a set of Indifference Curves. It
depicts the complete picture of a consumer’s preferences.

49. We know that a consumer is indifferent among
the combinations lying on the same indifference
curve.
However, it is important to note that he prefers
the combinations on the higher indifference
curves to those on the lower ones.
This is because a higher indifference curve
implies a higher level of satisfaction. Therefore,
all combinations on IC1 offer the same
satisfaction, but all combinations on IC2 give
greater satisfaction than those on IC1.

50. Marginal Rate of Substitution
It is the rate at which a consumer is prepared to
exchange a unit of good X for Y or it is a rate at which
the consumer is willing to substitute one good for the
other.
MRSxy = ∆Y/ ∆X
or
MRS = sacrifice / gain

51. Combination Burger Clothing MRS
A 1 12 –
B 2 6 6/1=6
C 3 4 2/1=2
D 4 3 1/1=1
In our Example Peter will have the following MRS:

52. Peter initially gives up 6 units of clothing to get an extra
unit of food. Hence, the MRS is 6. Similarly, for
subsequent exchanges, the MRS is 2 and 1 respectively.
MRS of X for Y is the amount of Y whose loss can
be compensated by a unit gain of X, keeping the
satisfaction the same.
It is the slope of Indifference Curve

53. As Peter accumulates more units of food, the MRS
starts falling – meaning he is prepared to give up
fewer units of clothing for food.
There are two reasons for this:
• As Peter gets more units of food, his intensity of
desire for additional units of food decreases.
• Most of the goods are imperfect substitutes for one
another. If they could substitute one another
perfectly, then MRS would remain constant.

54. Properties of Indifference Curve
IC slopes downward
IC is convex to the origin
Higher IC shows higher level of
satisfaction
ICs do not touch or intersect
each other
IC does not touch X-axis or Y-axis

55. 1. IC slopes downward
• IC slopes downward from left to right
• It means that IC has a negative slope
• It implies that if the consumer decides to have more of one
good, he must have less of the other
• At combination A Peter had 1 burger and 12 clothing. Moving
from A to B, he had 2 burgers (1 more than before) and 6
clothing (6 less than before)
• That means more of one good must be combined with less of
the other because of the monotonic preference of the
consumer.

56. MONOTONIC PREFERENCE
It means that a rational
consumer always prefers more
of a commodity as it offers
him a higher level of
satisfaction.

57. 2. IC is convex to the origin
• It means that slope of IC tends to decline, as we move along the
IC from left to right.
• The slope of IC declines because of declining / diminishing MRS
• As Peter substitutes clothing for burger, he is willing to part with
less and less clothing. This is the diminishing marginal rate of
substitution.
• The rate gives a convex shape to the indifference curve.

58. However, there are two extreme scenarios:
• Two commodities are perfect substitutes for each other –
In this case, the indifference curve is a straight line, where
MRS is constant.
• Two goods are perfect complementary goods – An
example of such goods would be socks and shoe. In such
cases, the IC will be L-shaped and convex to the origin.

59. 3. Higher IC shows higher satisfaction
• Higher IC i.e. IC2 will indicate
higher level of satisfaction as
compared to IC1
• At IC2, the consumer will be
enjoying more of one or both
the commodities, hence, it
gives higher level of
satisfaction

60. 4. ICs do not touch or intersect
• Consider point A and B, they are on
same IC1
• Therefore satisfaction derived by them
must be equal i.e. A = B
• Likewise A = C in case of IC2
• Since A = B, A = C we can conclude that
B = C
• But this cannot be possible because
both of them are on different ICs and
gives different level of satisfaction to
the consumer

61. 5. IC do not touch X-axis or Y-axis
• IC considers the consumption of
two goods
• If IC touches X-axis, it would mean
that the consumption of Good-X is
zero
• Likewise, If it touches Y-axis, it
would mean consumption of Good-
Y is zero

62. Consumer’s Budget
Assume that Peter has a budget of Rs. 100 to be spent on Burger and
Clothing
Also the price of Burger is Rs.5 per unit and price of Clothing is Rs.10
per unit

63. Units of Burger Units of Clothing
0 10
4 8
8 6
10 5
14 3
20 0
Budget Set of Peter

64. Budget Set
It refers to attainable combinations of a set of two goods, given
prices of goods and income of the consumer
PXQX + PyQy ≤ Y
It is also known as Budget Constraint as it shows the limit up to
which a consumer can buy a set of two goods with his given
income

65. Budget Line
It is a line showing different possible combination of two goods
which a consumer can buy, given his budget and prices of the
commodity
Any point on budget line
shows that the consumer has
spent his entire income on
either commodities
It is also known as Price line
because it shows price ratio
between two commodities

66. Attainable and Non-Attainable
Combinations

67. Slope of Budget Line
It shows the rate at which market price allows the
consumer to substitute good x for good.
It is expressed as Px / Py
It is also known as market rate of exchange.
The slope of budget line is constant because prices of
both the commodities are taken as given in the market.

68. Budget Line slopes downward because considering the
income and prices of the commodities, Peter can buy
more of Burger only when he buys less of Clothing

69. Shifting in Budget Line
Budget Line shifts either forward or backward
(without changing its slope) when income of the
consumer increases or decreases respectively.
Here prices are assumed to be constant

71. Rotation in Budget Line
• Budget line rotates to the right when Px or Py falls
Y Y
X X
Good - X Good - X
Good - Y
Good - Y

72. • Budget line rotates to the left when Px or Py rises
YY
XX
Good - XGood - X
Good - YGood - Y

73. Consumer’s Equilibrium
In case of indifference curve analysis, 2 conditions need to be
satisfied
• MRSxy = Px / Py
• IC should be convex at the point of equilibrium
The rate at which the consumer is willing to substitute X for Y
COINCIDES with the rate at which the market allows the consumer
to substitute X for Y

75. • There are three indifference curves IC1, IC2 and IC3.
• The price line PT is tangent to the indifference curve IC2 at
point C.
• The consumer gets the maximum satisfaction or is in
equilibrium at point C by purchasing OE units of good Y and OH
units of good X with the given money income.
Explanation

76. The consumer cannot
be in equilibrium at
any other point on
indifference curves.
Why??

77. Point R and S lie on lower indifference curve IC1 but yield less
satisfaction.
As regards point U on indifference curve IC3, the consumer no
doubt gets higher satisfaction but that is outside the budget
line and hence not achievable to the consumer.
The consumer’s equilibrium position is only at point C where
the price line is tangent to the highest attainable indifference
curve IC2 from below.
Bcoz…..

78. Thank You
By – Priyanka Chhabra