Microeconomics Lecture Notes PDF

Microeconomics Lecture Notes 1: Chronology, Cardinal and Ordinal Analysis  https://t.me/economindsbyamit https://play.google.com/store/app s/details?id=co.lct.mtrdgf&pcamp EconoMinds by Am...

Microeconomics Lecture Notes 1: Chronology, Cardinal and Ordinal Analysis  https://t.me/economindsbyamit https://play.google.com/store/app s/details?id=co.lct.mtrdgf&pcamp EconoMinds by Amit Sir aignid=web_share Chronology, Cardinal & Ordinal Utility Analysis Consumer Behaviour Analysis It examines the process by which a consumer makes decisions among various goods and services, considering their income and the prices of those goods and services. The goal is to attain the highest level of satisfaction, referred to as the consumer equilibrium point. There are two methods to identify and explore consumer equilibrium. Cardinal Approach: ✓ Given by Alfred Marshall in his book Principles of Economics (1890) ✓ Satisfaction can be measured in absolute numbers ✓ Standard unit is utils Ordinal Approach: ✓ Originally introduced by Pareto in 1906 ✓ Satisfaction cannot be measured in absolute numbers, indeed can be ranked in order of preferences ✓ Indifference Curve Analysis (initially developed by Francis Ysidro Edgeworth in 1881). Later on Pareto was the first one to actually draw these curves in 1906. Hicks and R.G.D. Allen published their comprehensive work based upon Edgeworth, Pareto & Slutsky in 1934 ✓ Revealed Preference Theory (Paul Samuelson- 1938) Utility can be defined as the want-satisfying power of a commodity, representing a psychological phenomenon. There are distinctive features associated with utility: 1. Subjectivity: Utility is subjective and pertains to mental satisfaction. For instance, a drunkard may find utility in liquor, whereas a teetotaler may perceive no utility in it. 2. Relativity: Utility is relative, varying across different factors such as time, place, and individuals. What holds utility for one person in a specific situation may not be the case for another. 3. Not Necessarily Useful: Utility does not necessarily equate to practical usefulness. As an example, cigarettes may not be considered useful, but they fulfill the utility of a smoker by providing satisfaction. The historical timeline outlines key developments in economic thought and theory: 1699: Charles Davenant first stated the law of demand, with indications that George King also demonstrated it during the 17th century. 1738: Daniel Bernoulli coined the term 'Utility' in 1738 while addressing the St. Petersburg Paradox. 1780: Jeremy Bentham, regarded as the Father of Utilitarianism, advocated the utility principle in his book "An Introduction to the Principles of Morals and Legislation." 2|Page  https://t.me/economindsbyamit https://play.google.com/store/app s/details?id=co.lct.mtrdgf&pcamp EconoMinds by Amit Sir aignid=web_share 1854: Herman Gossen formulated the law of diminishing marginal utility, introducing the concept of marginal utility. This idea remained unnamed until the Marginalist Revolution. 1881: Francis Ysidro Edgeworth presented the indifference curve, marking the First Generation of the Marginalist Revolution in the late 19th century. Late 19th Century: The first generation included economists like Stanley Jevons, Carl Menger, and Leon Walras, who emphasized the dependence of value on utility. Early 20th Century: The second generation of the Marginalist Revolution involved economists such as Marshall, Wicksteed, Eugen von Bohm-Bawerk, and Pareto. Alfred Marshall documented the graphical presentation of the law of demand in his 1890 book "Principles of Economics." 1890: Marshall continued Gossen’s Law of Diminishing Marginal Utility, stating that the additional benefit from an increase in the stock of a commodity diminishes with each increase in the existing stock. 1906: Pareto was the first to draw indifference curves. 1915: Slutsky derived a theory of consumer’s choice based on indifference curves, but it went unnoticed due to wartime. 1934: Hicks and R.G.D. Allen published a comprehensive work based on Edgeworth, Pareto, and Slutsky, introducing the concept of diminishing marginal rate of substitution. Marginal Utility Analysis by Alfred Marshall in 1890 It is based on the following assumptions: 1. Cardinal Measurability of Utility: Marshall assumes that utility is a measurable and quantifiable entity. In other words, he believes that the satisfaction or utility derived from a good or service can be assigned numerical values. 2. Money is the Measuring Rod of Utility: Marshall asserts that the amount of money a person is willing to pay for a unit of a good is a measure of the utility derived from that good. Money serves as the standard measuring rod for utility. 3. Constancy of the Marginal Utility of Money: Marshall assumes that the marginal utility of money remains constant. This means that the additional satisfaction or utility derived from an additional unit of money remains the same. 4. Hypothesis of Independent Utility: The total utility derived from a collection of goods is considered the sum total of the separate utilities of each individual good. Marshall assumes that the utilities of different goods are independent of each other. 5. Law of Diminishing Marginal Utility: Marshall adheres to the Law of Diminishing Marginal Utility, stating that the additional benefit a person receives from an increase in the stock of a good diminishes with each successive increase in the quantity of that good. 6. Independence of Marginal Utility for Each Good: Marshall assumes that the marginal utility of each good is independent, meaning that the change in the quantity consumed of one good does not affect the marginal utility of another good. 7. Uniform Quality and Size: Every unit of the good consumed is assumed to be of the same quality and size. This assumption simplifies the analysis by considering homogeneous units of the good. 3|Page  https://t.me/economindsbyamit https://play.google.com/store/app s/details?id=co.lct.mtrdgf&pcamp EconoMinds by Amit Sir aignid=web_share 8. Continuous Consumption: Marshall assumes continuous consumption of the good, implying that there are no breaks or interruptions in the consumption process. 9. Suitable Quantity Consumed: The consumer is assumed to be consuming a suitable quantity of the good, implying that the quantity consumed is neither too large nor too small. 10. No Change in Consumer Factors: There is no change in the income, tastes, fashion, and habits of the consumer. Marshall holds these factors constant for the analysis. 11. No Change in Prices of Substitutes and Complements: Prices of substitute goods and complementary goods are assumed to remain constant throughout the analysis. These assumptions provide the foundation for Marshall's Marginal Utility Analysis, allowing for the examination of how changes in the quantity consumed of a good impact the marginal utility and, consequently, the consumer's behavior. ✓ When TU rises at an decreasing rate, MU falls ✓ When TU reaches its maximum point, MU is 0 ✓ When TU starts falling at decreasing rate, MU falls further and becomes negative MU n = TU n − TU n −1 TU MU = Q Units TU MU 1 20 20 Gossen First Law (By Herman Heinrich 2 35 15 Gossen 1850s) 3 45 10 The additional utility which a person derive from the consumption a commodity diminishes, 4 50 5 that is Total Utility increase at a diminishing 5 50 0 rate. In short, MU continues to diminish 6 45 -5 7 35 -10 4|Page  https://t.me/economindsbyamit https://play.google.com/store/app s/details?id=co.lct.mtrdgf&pcamp EconoMinds by Amit Sir aignid=web_share Cardinal Approach in One Good Case & Two Good Case: MUx = Px MUx MUy MUm = MUx MUm = = Px Px Py Gossen Second Law (By Herman Heinrich Gossen 1850s) At equilibrium an agent will allocate expenditures so that the ratio of marginal utility to price (marginal cost of acquisition) is equal across all goods and services. Law of Equi-Marginal Utility Utility Maximisation One Good Case: Let a consumer consumes q1 units of a good and he derives utility as: U1 = U1 ( q1 )  Total Utility dU1 U '1 = U '1 ( q1 ) =  Marginal Utility, such that; dq1 dU1 d 2U1  0 and  0  TU is rising at a decreasing rate and MU is positive but decreases as dq1 dq 21 more and more units of q1 are being consumed. So, as more and more units of good is being consumed, there is an additional to the total utility. But since money is being spent to get this additional utility, so the consumer is sacrificing utility from money. Thus, the net utility is defined as Total Utility obtained – Total Utility sacrificed. 5|Page  https://t.me/economindsbyamit https://play.google.com/store/app s/details?id=co.lct.mtrdgf&pcamp EconoMinds by Amit Sir aignid=web_share Total Utility Obtained: As more units of a good are consumed, the total utility obtained increases. According to the Law of Diminishing Marginal Utility, each additional unit contributes less and less to the total utility, but there is still an overall increase in satisfaction. Total Utility Sacrificed: To acquire these additional units of the good, the consumer has to spend money. The money spent represents an opportunity cost, as it could have been used to acquire other goods or services. The total utility sacrificed is, therefore, the satisfaction or utility that the consumer foregoes by spending money on the chosen good. Net Utility: The net utility is then calculated as the difference between the total utility obtained and the total utility sacrificed. It reflects the overall satisfaction or well-being derived from the consumption of the additional units of the good, considering both the positive contribution of the good and the negative aspect of spending money. Marginal utility of money The marginal utility of money refers to the value or satisfaction that a consumer assigns to an additional unit of currency, such as a rupee. This concept is subjective, meaning that it is determined by the individual consumer based on their preferences, needs, and circumstances. In utility analysis, the marginal utility of money is often assumed to be constant. This assumption simplifies the analysis and allows economists to make predictions about consumer behavior. The idea is that, for a given individual and under certain conditions, the additional satisfaction or utility gained from an extra unit of money remains the same. The assumption of constant marginal utility of money is a part of broader economic theories, including those related to consumer choice and demand. While this assumption may not hold true in every real-world scenario, it provides a useful and convenient framework for understanding and analyzing consumer decision-making in the context of budget constraints and preferences. Derivation of Demand Curve under Marshallian Utility Approach Getting back to the equation of Net utility (V), Refer to the session video for this segment As per the FOC, MUx = ʎPx or Px = MUx/ʎ Let Px rises, MUm i.e. ʎ is constant by assumption, this implies the LHS is greater than RHS. To bring back the equilibrium, the RHS component should rise. This implies MUx should rise. This further implies that MUx can only rise, when quantity consumed of x is reduced due to LDMU. Hence, Px when rises, X falls or vice-versa. 6|Page  https://t.me/economindsbyamit https://play.google.com/store/app s/details?id=co.lct.mtrdgf&pcamp EconoMinds by Amit Sir aignid=web_share MUx Px =  Inverse Demand Function  Nature of Demand Curve under Marshallian Approach As per the assumption of Utility Analysis, it is assumed that in case of 2-good, both the goods so not related to each other. The price elasticity of demand under Marshallian Utility Approach is 1. Limitations: Utility is not cardinally measurable: Marshall assumed that utility could be measured and quantified in a cardinal manner, assigning numerical values. However, utility is inherently subjective and varies among individuals, making precise measurement challenging. MUm is not constant: The assumption of constant marginal utility of money (MUm) simplifies analysis but may not hold in reality. Changes in income levels, inflation, and other economic factors can affect the marginal utility of money. Utilities are not independent: Marshall's assumption of the independence of utilities implies that the satisfaction derived from one good is not influenced by the consumption of another. In reality, goods are often interrelated, and the consumption of one can impact the satisfaction derived from another. Fails to explain Giffen Paradox: The Giffen Paradox challenges the traditional law of demand by suggesting that, in certain circumstances, an increase in the price of a good can lead to an increase in its quantity demanded. Marshall's utility analysis struggles to explain such paradoxical situations. Marshall ignored income effect and can't separate Income Effect and Substitution Effect: Marshall's analysis did not explicitly differentiate between income and substitution 7|Page  https://t.me/economindsbyamit https://play.google.com/store/app s/details?id=co.lct.mtrdgf&pcamp EconoMinds by Amit Sir aignid=web_share effects when prices change. Modern economic theory recognizes the importance of distinguishing these effects, as a price change can influence both the quantity demanded and the consumer's real income. Ordinal Approach: ✓ Originally introduced by Pareto in 1906 ✓ Satisfaction cannot be measured in absolute numbers, indeed can be ranked in order of preferences ✓ Indifference Curve Analysis (initially developed by Francis Ysidro Edgeworth in 1881). Later on Pareto was the first one to actually draw these curves in 1906. Hicks and R.G.D. Allen published their comprehensive work based upon Edgeworth, Pareto & Slutsky in 1934 The Ordinal Approach represents a departure from the Cardinal Approach, emphasizing that consumers cannot measure satisfaction numerically or in specific units. Instead, this approach suggests that consumers rank or order their preferences for different goods and services without assigning precise numerical values to the satisfaction derived from each. Key characteristics of the Ordinal Approach include: 1. Non-Measurability of Satisfaction: Unlike the Cardinal Approach, which assumes that satisfaction or utility can be measured numerically, the Ordinal Approach rejects the idea of measuring utility in specific units. It acknowledges the subjective nature of satisfaction. 2. Ranking Preferences: In the Ordinal Approach, a consumer makes decisions based on the relative ranking of preferences. Rather than quantifying satisfaction, the consumer simply arranges goods and services in order of preference. This allows for a comparison of the desirability of different options. 3. No Requirement for Units of Measurement: The approach asserts that there is no need for a consumer to measure satisfaction in specific units. Instead, the focus is on the consumer's ability to express preferences and make choices based on the order of those preferences. 4. Consumption Decisions Based on Rankings: Consumers, according to the Ordinal Approach, make consumption decisions by comparing the rankings of different goods and services. A consumer chooses the option that is ranked higher in preference. 5. Rationality - A consumer is assumed to be rational. The sole motive of the consumer is to maximise the level of satisfaction. Thus, the consumer will always choose the best bundle among all the available bundles. 6. Well-defined Preferences - A consumer is assumed to have well-defined preferences for all the possible bundles, i.e. the consumer exactly knows his choices and preferences. 7. Comparison - A consumer can compare any two consumption bundles and can accordingly either prefer one consumption bundle over another consumption bundle or 8|Page  https://t.me/economindsbyamit https://play.google.com/store/app s/details?id=co.lct.mtrdgf&pcamp EconoMinds by Amit Sir aignid=web_share be indifferent towards both (indifferent means that for the consumer both the commodities are equally good). 8. Monotonic Preferences : A consumer is assumed to have monotonic preferences. Consumer's preferences are said to be monotonic if, he/she prefers those consumption bundles which have at least more of one good and no less of the other good than other consumption bundles. Example: Consider two consumption bundles, bundle A (3, 5) and bundle B (3, 2), then, according to the assumption of monotonic preferences, a consumer will prefer bundle A over bundle B. This is because bundle A has more units of good 2 (i.e.5 units as compared to only 2 units in bundle B) and no less of good 1. 9. Substitution between Goods : If the preferences are monotonic, then a consumer can be indifferent between any two bundles only if the bundle consisting of more of one good has a lesser amount of the second good as compared to the other bundle. Example: Consider two consumption bundles- Bundle A (5, 8) and Bundle B (3, 10). In this case, the consumer can be indifferent between Bundle A and Bundle B. This is because Bundle A has more of good 1 but less of good 2 than bundle B. This implies that the consumer cannot clearly prefer one bundle over the other and hence, can be indifferent between the two. 10. Diminishing Rate of Substitution - If a consumer prefers a consumption bundle that has comparatively more of good 1 and less of good 2, then according to the diminishing rate of substitution, the amount of good 2 a consumer is ready to give up for an additional unit of good 1 declines or diminishes with successive increase in the amount of good 1. In other words, if the consumer consumes more and more of good 1, then his/her willingness to sacrifice good 2 for additional units of good 1 will go on diminishing i.e. as the amount of good 1 increases, the rate of substitution between good 1 and good 2 falls. 11. Consistency of Preferences - A consumer is assumed to be consistent in his/her preferences. Consistency in preferences implies that if a consumer prefers good 1 over good 2 in one period of time, then he/she will not prefer good 2 over good 1 in any other time period. In other words, it is assumed that the consumer has the same preferences across all time periods. 12. Transitivity of Preferences - Transitivity of preferences implies that if, a consumer prefers good 1 over good 2 and prefers good 2 over good 3, then he/she would also prefer good 1 over good 3, i.e. if, Good 1> Good 2 and Good 2 > Good 3 Then, according to transitivity of preferences Good 1 > Good 3 Indifference Curve An indifference curve is a graphical representation that illustrates different combinations of two goods that yield the same level of satisfaction or utility for a consumer. In simpler terms, it represents the combinations of goods where the consumer is indifferent, meaning they derive an equal level of satisfaction from any point on the curve. 9|Page  https://t.me/economindsbyamit https://play.google.com/store/app s/details?id=co.lct.mtrdgf&pcamp EconoMinds by Amit Sir aignid=web_share 2 In the above figure, IC is the Indifference Curve. Each bundle on the IC shows those combinations of two goods that yield the consumer the same level of satisfaction. For example, in the figure, Bundle A and Bundle B are on the same IC. Thus, the two consumption bundles provide the consumer with the same level of satisfaction. Downward Sloping to the Right: The downward slope of an indifference curve to the right indicates that as the consumer moves along the curve, giving up some quantity of one good, they must receive an increasing quantity of the other to maintain the same level of satisfaction. This reflects the principle of diminishing marginal rate of substitution and aligns with the assumption of monotonic preferences, where more of a good is preferred to less. Slope of IC and Marginal Rate of Substitution (MRS): The slope of an indifference curve at any point is equal to the marginal rate of substitution (MRS). The MRS represents the rate at which a consumer is willing to give up some amount of one good in exchange for an additional unit of another while keeping utility constant. The magnitude of the slope reflects the consumer's willingness to trade between goods, and the convex shape of the curve indicates that this rate diminishes as more of one good is acquired. i.e. MRS shows the rate at which the consumer is willing to sacrifice good Y for an additional unit of good X. 3. Shape of Indifference Curve: 10 | P a g e  https://t.me/economindsbyamit https://play.google.com/store/app s/details?id=co.lct.mtrdgf&pcamp EconoMinds by Amit Sir aignid=web_share As the consumer moves down along the indifference curve to the right, the slope of the indifference curve (measured by the Marginal Rate of Substitution - MRS) decreases. The decrease in the slope (MRS) is explained by the principle of diminishing marginal utility. As the consumer consumes more of one good, the marginal utility of that good falls. This means that each additional unit of the good provides less additional satisfaction. Simultaneously, as the consumer sacrifices some units of the other good, the marginal utility of the sacrificed good rises. This implies that the consumer is willing to give up less and less of the sacrificed good for each additional unit of the other good consumed. The combination of diminishing marginal utility and the rising marginal utility of the sacrificed good leads to a decreasing MRS as we move down the indifference curve. The diminishing MRS along the indifference curve indicates a convex shape, signifying that the consumer is willing to trade off goods at a decreasing rate. This is consistent with the economic concept of diminishing marginal rate of substitution. In the above figure, IC is the Indifference Curve. At point A, At point B, MRS at B < MRS at A, so MRS has fallen. 4. Two indifference curves never cross each other : Let us understand this property of IC with the help of a diagram. Suppose, there are two indifference curves IC 1 and IC 2 that intersect each other at point B. We can observe that point B and point P lie on the same indifference curve, IC 1. This implies 11 | P a g e  https://t.me/economindsbyamit https://play.google.com/store/app s/details?id=co.lct.mtrdgf&pcamp EconoMinds by Amit Sir aignid=web_share that the consumer must be indifferent between the two consumption bundles B and P. Similarly, point B and point Q lie on the same indifference curve, IC 2. This implies that the consumer must also be indifferent between the two consumption bundles B and Q. i.e. B ( X , Y ) ∼ P (X,Y) and B ( X , Y ) ∼ Q ( X , Y ) By the axiom of transitivity, the above analysis implies that a consumer must be indifferent between bundle P and bundle Q i.e. P ( X , Y ) ∼ Q ( X , Y ). However, this is not possible because bundle P and bundle Q lie on different IC. Hence, the two consumption bundles cannot provide the consumer the same level of satisfaction. Thus, it can be concluded that two IC cannot cross each other. Axioms of Indifference Curve Analysis: Indifference curve analysis is based on certain axioms or assumptions that define how individuals make choices. These axioms ensure the consistency and logical behaviour of consumer preferences. Here are the key axioms: 1. Completeness Axiom: Consumers can compare and rank all possible combinations of goods. For any two bundles A and B: Either A is preferred to B (A≻B), B is preferred to A (B≻A), or The consumer is indifferent between A and B (A∼B). 2. Transitivity Axiom: Consumer preferences are consistent across comparisons. If: A≻B and B≻C, then A≻C. Similarly, if A∼B and B∼C, then A∼C. 3. Non-Satiation (Monotonicity) Axiom: Consumers prefer more of a good to less, assuming other factors remain constant. This means indifference curves slope downward, as giving up one good requires compensation with more of another to maintain utility. 4. Convexity Axiom (Diminishing Marginal Rate of Substitution): Indifference curves are convex to the origin because the marginal rate of substitution (MRS) decreases as a consumer substitutes one good for another. Consumers prefer balanced bundles over extremes. 5. Continuity Axiom: Preferences are continuous, meaning there are no abrupt jumps in the indifference curves. Small changes in the quantity of goods lead to small changes in utility. 6. Rationality Axiom: Consumers are rational, meaning they aim to maximize their utility given their preferences and constraints. Their choices are consistent with their preferences. Indifference Map: 12 | P a g e  https://t.me/economindsbyamit https://play.google.com/store/app s/details?id=co.lct.mtrdgf&pcamp EconoMinds by Amit Sir aignid=web_share An indifference map is a graphical representation that consists of a family or collection of indifference curves. Each curve within the map represents a different level of satisfaction or utility for the consumer. The term "indifference" here means that all points on a particular curve provide the consumer with an equal level of satisfaction. Therefore, the consumer is indifferent between any two points on the same indifference curve. Higher indifference curves on the map represent higher levels of satisfaction, while lower curves represent lower levels of satisfaction. The ranking of indifference curves reflects the consumer's preferences, with curves further from the origin indicating greater satisfaction. Indifference maps help visualize how a consumer's preferences change as they move to curves farther from the origin. A consumer would prefer points on higher indifference curves to points on lower curves because they represent combinations of goods that yield higher satisfaction. The above figure depicts an Indifference Map comprising of six indifference curves (from IC1 to IC6). As the consumer moves farther away from IC1 to higher indifference curves the level of satisfaction derived by the consumer increases. IC6 depicts the highest level of satisfaction. On the other hand, IC1 depicts the lowest level of satisfaction. Indifference Curves: Special Cases Indifference Curves between Indifference Curves between Neutral and Good Bad and Good 13 | P a g e  https://t.me/economindsbyamit https://play.google.com/store/app s/details?id=co.lct.mtrdgf&pcamp EconoMinds by Amit Sir aignid=web_share Indifference Curves between Neutral and Good Satiation point is said to occur when MUx = 0 or MUy = 0. In the figure, after ox1, the consumer is attaining the point of satiation in good x, where MUx < 0 becomes negative. After ox1, the good x is bad, but MUy > 0, so the MRSxy = MUx/MUy > 0, which implies IC curve is upwards sloping. Similarly, after point oy1, the good y becomes bad. If both x and y becomes bad, then MUx < 0 and MUy < 0, then IC is negativelyIC, sloped, Bliss but is and Point concave Pointtoofthe origin. In this case, the consumer can attain higher Satiation satisfaction by moving down to point S, which is termed as Bliss Point. Consumer’s Budget The maximising behaviour of the consumer is constrained by his limited income. With only a limited income a consumer cannot purchase all that he/she wants. The availability of consumption bundles to a consumer depends mainly on the following two factors. Price of goods and services ( P ) Income of the consumer ( M ) Given the income of the consumer and the prices of the goods and services, a consumer can purchase only those combinations of goods and services such that his total expenditure on the goods and services is less than or equal to his income. Budget Set A budget set represents those combinations of consumption bundles that are available to the consumer given his/her income level and at the existing market prices. In other words, it 14 | P a g e  https://t.me/economindsbyamit https://play.google.com/store/app s/details?id=co.lct.mtrdgf&pcamp EconoMinds by Amit Sir aignid=web_share represents those consumption bundles that the consumer can purchase using his/her money income ( M ). Based on the above variables, the budget set or the consumption bundles available to the consumer will be governed by the following inequality condition: Note: The use of ≤ sign in the constraint, implies that the total amount spent on two goods together should be less than or equal to his/her given income level. In other words, a particular consumption bundle is available or affordable to a consumer if the total money spent on both the goods is less than or equal to the total available money income. The budget equation is of the following form. P1x1 + P2x2 = M Solving for x2 : P2x2 = M – P1x1 where, is the vertical intercept. It represents the amount of x 2 that the consumer can purchase if he spends his entire income on good 2. represents the slope of budget line. This is also called the price ratio. The negative sign depicts the negative slope of the budget line from left to right. Similarly, the above equation can be solved for x1 P1x1 = M – P2x2 where, is the horizontal intercept and it represents the amount of x1 that a consumer can purchase if he spends his entire income on good 1. Based on the above information we can draw the budget line as follows. 15 | P a g e  https://t.me/economindsbyamit https://play.google.com/store/app s/details?id=co.lct.mtrdgf&pcamp EconoMinds by Amit Sir aignid=web_share Increase in Money Income Decrease in Money Income Decrease in Price of Good-1 Increase in Price of Good-1 Decrease in Price of Good-2 Increase in Price of Good-2 Consumer Equilibrium A consumer attains equilibrium at the point where the budget line is tangent to the indifference curve. This optimum point is characterised by the following equality. Slope of the IC = Slope of the budget line 16 | P a g e  https://t.me/economindsbyamit https://play.google.com/store/app s/details?id=co.lct.mtrdgf&pcamp EconoMinds by Amit Sir aignid=web_share Absolute value of the slope of the IC = Absolute value of the slope of the budget line Graphically, the equilibrium can be depicted as follows. At this point, the budget line is tangent to the indifference curve. Observe that at this point the consumer's willingness to purchase (as given by the indifference curve) coincides with what the consumer can actually purchase (as given by the budget line). The optimum bundle is denoted by ( x 1 *, x 2 *). This point is the optimum or the best possible point. It should be noted that all other points lying on the budget line (such as point B and point C ) are inferior to ( x 1 * x 2 *) as they lie on a lower IC. Thus, the consumer can rearrange his consumption and again reach equilibrium where the marginal rate of substitution is equal to the price ratio. For example, at point B , MRS is greater than the price ratio (i.e. ). In this case, the consumer would tend to move towards point E by giving up some amount of good 2 to increase the consumption of good 1. Similarly, at point C , MRS is less than price ratio (i.e. ). In this case the consumer would tend to move towards point E by giving up some amount of good 1 to increase the consumption of good 2. 17 | P a g e  https://t.me/economindsbyamit https://play.google.com/store/app s/details?id=co.lct.mtrdgf&pcamp EconoMinds by Amit Sir aignid=web_share Some Special Cases: Concavity implies Increasing MRS, consumer When Px/Py < MRSxy will choose only one good. Equilibrium is at No interior solution is possible point Q or P and not at R EconoMinds by Amit Sir Android: https://play.google.com/store/apps/details?i d=co.lct.mtrdgf&pcampaignid=web_share 18 | P a g e