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Consumers Equilibrium

Under Ordinal Utility Analysis i.e., under Indifference Curve Analysis – the consumer will be in equilibrium when two conditions are fulfilled. They are:
  • The budget line / price line should be tangent to the Indifference curve
  • The marginal rate of substitution, between two commodities at that particular point should be equal
This concept could be explained in the form of a diagram.
Description: 19639.png
The consumer has before him, the indifference map, in which IC4 represents the higher level of satisfaction and the IC1 represents the lower level of satisfaction and the curve PL represents the Price Line.
The consumer can’t select IC3 and IC4, because his income willn’t support. Hence the consumer has to stay on IC1 or IC2, which can be purchased with the income he has. But the consumer doesn’t want to stay on IC1, because this represents lower level of satisfaction. Hence the consumer prefers IC2, since it can be obtained with his income. On this IC2, the consumer will be in equilibrium at a point E, where the consumer is consuming 2 units of commodity A and 3 units of commodity B.
The ordinal theory can be understood with the help of the cardinal theory as they can be put in a single formula
MRSxy = Px/Py = MUx/MUy.

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