Consumer’s Equilibrium with Utility Analysis

One-Commodity Equilibrium:

When a consumer is purchasing one com­modity, he stops buying when its price and utility have been equated.

At this point, his total utility is the maximum. He is said to be in equilibrium at this point, because he is getting maximum satisfaction and he will buy neither more nor less.

Only a change in price will lead to a change in the quantity demanded.

Equilibrium with More Than One Commodity:

According to Mashallian utility analysis, when expenditure of a consumer has been completely adjusted, that is, when marginal utility in each direction of his purchases is the same, it is called consumer’s equilibrium. Then he has no desire to buy any more of one commodity and less of another.

Given a set of market prices, his wants and his income, the consumer may be said to be in equilibrium when marginal utilities have been equalized and maximum satisfaction obtained. There will then be no inducement to revise his scheme of expenditure.

He will continue to buy the same commodities and in the same quantities until either his income or his wants or prices change. Adjustment of wants to one another and to his environments is a sign of consumer’s equilibrium. For a consumer “to be in equilibrium with respect to all goods, the marginal significance of all goods in terms of money must equal their money prices.”

In order to derive maximum satisfaction from the amount of money that a consumer has, he will so apportion his expenditure that the marginal utilities of the goods purchased will be in proportion to their prices.

Thus, a consumer will be in equilibrium when

M.U. of X /price of X = M.U. of Y / price of Y/ M.U. of Z / price of Z = k

This is also called the principle of proportionality.

In case the price of one commodity rises, less of this commodity and more of the other commodities will be purchased so that the proportion will be restored. In the case of durable goods it may not be possible to maintain proportionality. The above equation will hold good only if the consumers’ tastes and other circumstances remain unchanged and the commodities are perfectly divisible.

Now if price of commodity X falls, if the fraction is still to be equal to k which is constant, the numerator, i.e., the marginal utility of X must also fall. This will happen only when the consumer consumes more of X. Hence a fall in the price of X leads to more of X being demanded. The position may, however, seem unrealistic. In real life, no sensible consumer bothers about making minute marginal adjustments. Human being are not calculating machines.

The above explanation of a consumer’s equilibrium has been given with the help of the concept of utility; it is, therefore, called the analysis of demand or consumer’s behaviour. Modern economists explain consumer’s equilibrium with the help of indifference curves referred to below in Appendix.

Shortcomings of the Utility Analysis:

We have given so far utility analysis of Consumers’ behaviour.

Utility analysis, also called the Marshallian analysis, as an approach to the study of consumer’s behaviour, rests on the following two fundamental assumptions:

(i) Utility is measurable and can be added or subtracted. In other words, utility is a quantifiable concept; and

(ii) Marginal utility of money remains constant as a consumer spends more and more of his money.

Both these assumptions have come under heavy fire by modern economists, the foremost amongst them being Professor J. R. Hicks. It has been pointed out by him that utility is a mental phenomenon and cannot, therefore, be measured in quantitative terms. Further, marginal utility of money increases as a consumer spends more and more of his income.

Marshall explained consumer’s behaviour assuming that utility is measura­ble and additive just as the weight or length of objects is measurable and additive. The consumer was, thus, assumed by Marshall to possess what modern economists call ‘cardinal’ measurement of utility. In other words, the consumer was assumed to be capable of assigning to every commodity or combination of commodities a number representing the amount of utility associated with it.

The numbers representing amounts of utility could be manipulated in the same fashion as weights. Assume for example that utility of ‘A’ is 15 units and the utility of ‘B’ 45 units. The consumer would like ‘B’ three times as strongly as A. The differences between utility numbers could be compared and the comparison could lead to a statement such as ‘A’ is preferred to ‘B’ twice as much as ‘C’ is preferred to ‘D’.

Thus, we see that the Marshallian assumption of cardinal measurement of utility is very restrictive. It demands too much from the human mind. Utility is a mental phenomenon and the precision in measurement of utility assumed by Marshall is unrealistic.

Secondly, Marshall assumed marginal utility of money to be constant in his analysis to show consumer’s behaviour in making his purchases. Marshall defended his assumption on the ground that as the consumer spent only a small fraction of his income on a particular good, his marginal utility of money does not increase to any significant extent while purchasing more units of it.

But actually, the marginal utility of money increases, as a consumer buys more and is left with less and less money. In view of these shortcomings the modern economists use indifference curve technique in place of Marshallian utility analysis. The indifference curve technique is free from these shortcomings.