Consumer Equilibrium and Indifference Theory

Rational Consumer Behavior

• A rational consumer buys an additional unit of a good if the perceived dollar value of the utility of that unit (marginal dollar utility) is greater than its market price.
• The equilibrium occurs where the marginal utility (MU) equals the market price (P).
• If MU > P, the consumer buys more, as the surplus is positive.
• If MU < P, the consumer buys less.
• If the price of good A rises such that MUA / MUB < PA / PB, the consumer buys less of good A and more of other goods.

Indifference Theory

• Indifference analysis measures satisfaction by ranking various combinations of goods in order of preference.
• It assumes that consumers can decide whether they prefer one combination of goods to another.
• A basket or bundle is a collection of goods or services that an individual might consume.

Indifference Curves

• The negative slope of the indifference curve is called the Marginal Rate of Commodity Substitution (MRS).
• The MRS shows the amount of one commodity that a consumer is prepared to give up in order to consume one more unit of another commodity and still maintain the same level of satisfaction.
• The MRS declines as one moves down on an indifference curve, known as Diminishing MRS.

Indifference Map

• An indifference map is a collection of indifference curves corresponding to different levels of satisfaction.
• The further out the curve, the higher the level of utility.

Properties of Indifference Curves

• Higher indifference curves are preferred to lower ones.
• The optimal choice occurs at the point where the consumer's budget line is tangent to the highest indifference curve.

Consumer Equilibrium

• At the point of equilibrium, the MRS must equal the ratio of the two prices (Px/Py).
• The rate at which the consumer would be willing to exchange X for Y is the same as the rate at which they are exchanged in the market place.
• The consumer's equilibrium is reached when the budget line is tangent to the highest indifference curve.

Income Consumption Curve

• The income consumption curve is the locus of points of consumer equilibrium resulting when only the consumer's income is varied.
• The Engel Curve shows the amount of a commodity that the consumer would purchase per unit of time at various levels of income.

This quiz covers the concept of consumer equilibrium and indifference theory, where the consumer's budget line is tangent to the highest indifference curve. It explores the conditions for optimal choice and equilibrium in consumer decision-making.