(a) What is the equilibrium of a consumer? [5 marks]
(b) Explain how a consumer attains equilibrium in spending his income. [15 marks]
Explanation
(a)The equilibrium of a consumer is a situation in which his satisfaction or utility from spending his income on various goods and services is maximized
(b) Alternative 1 In this approach, It is assumed that utility or satisfaction is measured in terms of money
In this case the consumer buys as much of a commodity as would make its price exactly equal to his estimate of the money value of the marginal utility of the commodity
In symbols, MUX = Px. This is the equilibrium condition.
OR Alternative 2 In this approach, it is assumed that utility is measured in units of utility called utils In this case, the consumer arranges his consumption in such a way that the marginal utilities of the commodities are proportional to their prices.
In symbols,
\(\frac{MUx}{MUy}\) = \(\frac{Px}{Py}\) This is the equilibrium condition
OR Alternative 3 In this approach also it is assumed that utility is measured In utils. In this case, the consumer arranges his purchases in such a way that the marginal utility per unit of money spent on acommodity is the same for all commodities purchased
In symbols,
\(\frac{MUx}{Px}\) = \(\frac{MUy}{Py}\) This is the equilibrium condition
Alternative 4 Again utility is measured in utils. In this approach a consumer arranges his purchases in such a way that for each commodity the marginal utility equals the utility of the price. In symbols,
MUX= λPx.
In addition, whatever approach is used,candidates must go on to show:
(i) What happens when the equilibrium condition is no longer satisfied because price rises or falls.
(ii) How equilibrium can be attained finally For example, in alternative 1, if the price of x, Px falls, the equilibrium condition would no longer be satisfied Marginal utility of x, MUx, would be greater than the Px i.e MUx > Px. To establish an equilibrium, MUx must fall to the same level as Px.
This happens when the consumer buys more of X. On the other hand, if the Px nses, again the equilibrium condition would not be satisfied MUx < Px. To attain an equilibrium, the consumer would buy less of x to raise the MUx to the same level as Px.