Chapter 2 - Consumer’s Equilibrium and demand analysis

Cardinal approach: This approach was developed by Alfred Marshall. As per this approach a
consumer can measure utility derived from the consumption of a given commodity numerically or
objectively.

Some Basic terms

• Utility is the quantitative measurement of satisfaction or it is a want satisfying power of a

• Utility measurable in cardinal numbers i.e., exact units such as 1, 2, 3 etc. is known as
cardinal utility.

• Utility is measured in units of pleasure called ‘utils’.

• According to Marshall utility can also be measured in terms of money or a price a consumer
is willing to pay.

For example, if a consumer is willing to pay Rs 150 for a book, then the utility of a consumer for this
book is equal to 150 units of money.

Therefore, utility of a good can be measured both in utilis and in terms of money.

The characteristics of Utility are

a. It differs in urgency of want for example utility of water will be more for a thirsty person than
to a hungry person.

b. It is subjective in nature i.e., differs from person to person for example consumption of
Burger may give more satisfaction to consumer A than to consumer B.

c. It is not essentially always useful like utility derived from the consumption of drugs, liquor
etc.

Marginal utility of Money

Marginal utility of money (MUm) refers to the worth of a unit of money (say one rupee) in terms of
satisfaction to a consumer in general. However, there is no defined value of marginal utility of money
and a consumer is expected to define it himself. Suppose a rupee can buy a basket of goods including
10 grams of sugar, 100 grams milk and 200 grams of wheat and the total utility a consumer derives
from this basket of goods is 4 utils. Then 4 utils is taken as marginal utility of money. Therefore MUm
= 4 utils. MUm is more for a poor people as compared to rich people, since poor people have less
money and majority of their wants are unsatisfied.

How to measure marginal utility of a commodity in terms of money

Marginal utility of a commodity is measured in units of pleasure called ‘Utils’, whereas price for a
commodity is paid in money. Therefore, it is important to convert marginal utility of a commodity in
terms of money. Marginal utility of a commodity in terms of money means the amount of money
that a consumer is willing to pay for the commodity.

Example – Suppose marginal utility of a commodity is 100 utils and marginal utility of one rupee for
the consumer is 4 utils. It implies that to get 4 utils utility a consumer is ready to pay Rs 1. Therefore

4 utils = 1 Rs
 1 utils = 1/ 4 Rs

100 utils = ¼ × 100 = 25 Rs

This implies that consumer is willing to pay Rs 25 for the commodity.

Therefore, Price of commodity/amt a consumer is willing to pay =

Two types of Utility

There are following two types of utility

1. Marginal utility (MU) – It refers to additional (extra) utility derived from the consumption of
an additional unit of a given commodity or it is addition to total utility (TU) when one more
unit of a given commodity is consumed. MU is also called slope of total utility since it shows
change in total utility.

Formula - MU = TUn – TU n-1 or ∆ TU∆ n; Where n is the unit of commodity consumed.

The concept of MU can be explained with the help of following imaginary table and graph

Table - A

Units of given good MU derived from the given

1 10

2 8

3 6

4 2

5 0

6 -2

As it can be seen from the table with each additional consumption of the given commodity its MU
keeps on falling. If we plot these units of commodity consumed and their respective MUs we get a
downward sloping straight line called MU curve. The area under MU curve shows TU.

1. Total utility (TU) - It refers to sum of all utilities derived from the consumption of all units of
a given commodity.

Mathematically TU = Sum of all MU. i.e., ∑MU

The concept of TU can be explained with the help of a table and diagram. In the below table TU is
calculated by adding MU of different units of commodity.

Units consumed MU (utils) TU (utils)

1 10 10

2 7 17
 3 4 21

4 0 21

5 -2 19

As it can be seen from the above schedule as units of consumption of given commodity increases TU
derived from it rises at diminishing rate and due to which TU curve is concave to origin.

Relationship between TU and MU with the help of schedule.

The relationship between MU and TU can be explained with the help of following table

Units of given MU derived from the TU

1 10 10

2 8 18

3 6 24

4 2 26

5 0 26

6 -2 24

Relationship between Total Utility (TU) and Marginal Utility (MU):

1. MU is the slope of TU and measures the rate of change in TU whereas TU = ∑MU

2. TU increases so long as MU is more than zero. Which implies as long as MU falls but remains
positive TU increases at diminishing rate.

3. When MU is zero, TU is maximum also called point of saturation because any more
consumption of given commodity does not add to total utility.

4. TU starts declining when MU becomes negative

The two laws of utility analysis are

1. Law of Diminishing marginal utility

2. Law of Equi - marginal utility

1. Law of Diminishing marginal utility

As per this law ‘when we consume more and more units of a particular commodity, the utility
derived from the consumption of each successive additional units goes on decreasing. This law is also
known as ‘Gussians first law of consumption’.

According to Prof. Marshall, this law states that whenever the units of a commodity consumed by the
consumer are increased, keeping other factors constant, the marginal utility of the commodity goes
on decreasing.

Example – A thirsty person gets maximum satisfaction from first glass of water. The satisfaction with
the second glass of water will be relatively lesser. With the further consumption a stage will come
when he would not require any glass of water.

Consumer’s equilibrium point

Consumer’s equilibrium point refers to the situation when a consumer spends his limited money
income on the purchase of a good or on the combination of goods in such a manner that he gets
maximum satisfaction and has no desire to change this good or combination of goods, with given
price and income.

Law of DMU and consumer’s equilibrium point

As per law of DMU, when a consumer buys single commodity say X, he obtains equilibrium when the
following two conditions are satisfied:

1. The marginal utility of a good X in money terms is equal to price of that good. In other words

MU of good X = Price of good x

MU of a Rupee

Where; MU of one Rupee is defined as “the extra utility when an additional rupee is spent on

other available goods in general and MU of one Rupee is assumed to be constant.

2. MU of product decreases with each additional consumption of good after consumer’s

The above two condition of consumer’s equilibrium can be explained with the help of following
imaginary table and diagram. Let us suppose a consumer buys good X, price of good X is Rs 6, and
suppose MUm = 1 util.
When he purchases the first unit, the utility that he gets is 12 utils. He has to pay only Rs. 6 for it, so
he will buy it and similarly, he compares the utility received from other units with the price paid. We
find that he will buy till 4th unit. because at the 4th unit both the conditions of equilibrium are met
that is MUx/MUm = price and MUx falls if he buys more. If he buys the 5th unit, he losses because
MUx/MUm < price. Therefore, the consumer will maximize his satisfaction by buying 4 units of this
commodity.

What if above conditions are not met

a) MUx/MUm > price : Marginal utility of good in terms of money is more as compared to price
paid by consumer therefore consumer buys more of good. Law of DMU operates with each
additional unit purchased that leads fall in its marginal utility and this process continues until
MUx/Mum becomes equal to Price of good again.
b) MUx/MUm < price : Marginal utility of good in terms of money is less as compared to price paid
by consumer therefore a consumer will never buy any unit of good X beyond equilibrium point.
In this situation he can increase his utility by buying less units of the commodity because in this
situation, Law of DMU operates which leads to rise in its marginal utility. This process continues
until, MUx/MUm becomes equal to price of good again.

Explanation of condition two -

MUx does not fall with additional purchase then a consumer will keep consuming the given
commodity and he will never strike equilibrium. Therefore, both the conditions must meet for a
consumer to be in equilibrium.

Check your knowledge based on consumer’s equilibrium as per Law of DMU

Q1. When MUm increases, how a rational consumer will react to this situation?

Ans. A consumer strikes equilibrium in case of single commodity when

MU of a product = Price of product.

MU of a Rupee
So, if MUm increases it means MUx/MUm < Px a consumer gets less satisfaction as compared to
price paid by him, so he will buy less of it than before.

Q2. A consumer is in equilibrium in purchase of single commodity, if the price of this good
increases, how a rational consumer will behave?

Ans. A consumer strikes equilibrium in case of single commodity when

• MU of a product = Price of product.

• MU of a Rupee

So if Px increases it means MUx/MUm < Px , a consumer gets less satisfaction as compared to price
paid by him, so he will buy less of it than before.

Multiple choice questions:

1. When TU is maximum, MU is

a. Zero b) negative c) positive d) none of these

2. Who gave the cardinal concept of utility?

a. Marshall b) Pigou c) hicks d) samuleson

3. According to utility analysis, utility :

a. Can be measured in terms of money

b. Can not be measured in terms of money

c. Can be measured in cardinal numbers

d. Both (a) and (c)

4. Marginal utility is

a. Utility from first unit of commodity consumed

b. The utility from last unit consumed

c. Total utility denoted by the number of commodity consumed

d. Always positive

5. Starting from an initial situation of consumer equilibrium, suppose that MU of a rupee

a. It will increase

b. It will decrease

c. It will remain unchanged

d. It will fall to zero

6. After satiety point, consumption of additional units of the commodity will cause :

a. TU to fall
b. TU to increase

c. TU to become negative

d. Increase in both TU and MU

7. Which of the following can be referred to as ‘point of satiety’ ?

a. MU is negative

b. MU is zero

c. MU is rising

d. TU is falling

8. According to utility approach, utility can be measured :

a. In monetary units b) in cardinal numbers c) both (a) and (b) d) neither

9. TU is _____________________

a. The sum of MU

b. Utility from first unit × number of units consumed

c. Always increasing

d. Utility from last unit × number of units consumed

10. When MU is negative, TU is

a. Zero b) diminishing c) maximum d) minimum

11. The consumer is in equilibrium and is consuming good X only. The MU from last unit
consumed of good X = 50 utils and MUm = 10 find the price of commodity X

a. Rs 5 b) Rs 40 c) Rs 10 d) Rs 4

Q12. State true or false

a. TU will increase even when MU decreases

b. TU increases as long as MU is positive

c. When MU is zero, TU is also zero

d. According to utility analysis, utility is cardinal

e. MU can never be negative

Q13. Answer the falling questions

a. Why should a consumer purchase more of a commodity when MU must decline as

b. How many units of a commodity will you consume, if you do not have to pay any price for it?

c. When the price of onion is very is very high, the poor man simply stops buying it. Explain the
economics of it, using utility analysis.
d. MU of a good is 72 utils and its price is Rs 10 per unit. Suppose MU of money for the
consumer is 6 utils. Should he increase or decrease his consumption to attain equilibrium and why? (
ans. consumer should increase consumption)

Q14. Important questions

a. Define utility.

b. What is TU? How is it derived from MU?

c. What is MU? How is it calculated? Explain it with the help of a schedule

d. State the law of DMU

e. What is cardinal utility?

f. How does a consumer reach equilibrium position when he buys only one commodity?
Explain with the help of MU schedule
Or
Determine consumer’s equilibrium with the help of utility analysis in case of single commodity with
the help of numerical example
Or
Given the market price of a good, how does a consumer decide as to how many units of that good to
buy? explain
Or
What happens if MU is not equal to price.