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All consumers strive to maximize their utility. We try to get as much satisfaction as we can. The consumer’s scale of preference is derived by means of indifference mapping that is a set of indifference curves which ranks the preferences of the consumer. Getting to the indifference curve which is farthest from the origin gives the highest total utility. Although the goal of the consumer is maximization of satisfaction, the means of achieving the goal is not clear. Higher indifference curve not only gives higher satisfaction but also are more expensive. Here we are confronted with the basic conflict between preferences and the prices of the commodities consumer wants to consume. With a given amount of money income to spent, we cannot attain the highest satisfaction but have to settle for less.
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Marginal Utility and Price The slope of the indifference curve shows the marginal rate of substitution of good X for good Y, while the slope of price line indicates the ratio between prices of two goods i.e. ( PX /PY). Consaumer equilibrium was represented as the combination of good X and good Y can be written as [math]\frac{MU of Good X}{Price of Good X}[/math] = [math]\frac{MU of Good Y}{Price of Good Y}[/math] Alternatively, [math]\frac{MU of Good X}{MU of Good Y }[/math] = [math]\frac{Price of Good X}{Price of Good Y}[/math] This equation explains that at the point of equilibrium the relative marginal utilities of good X and good Y should equal to their relative prices. In other words , if good X cost twice as much as good Y , then marginal utility of good X must yield double , then the consumer is in an optimal state. The slope of the budget constraint equal the relative prices of the two goods. In Fig-1, the slope of the price line equal to the price of goods X and good Y. It means the rate of substitution between the good X and good Y is 1:2. The relative marginal utilities of the two goods are reflected in the slope of the indifference curve. It is the marginal r ate of substitution which is equal to the relative marginal utilities of the two goods. At the point of optimal consumption E in fig-1 the budget constraint is tangent to the indifference curve IC2. Which means,
Or Marginal rate of substitution of X for Y = [math]\frac{PX}{PY}[/math]
The price line AB is tangent to the indifference curve IC2 . But the consumer cannot be in equilibrium at point E because it can obtain grater satisfaction by moving along the given price line .Consumers satisfaction increases by either moving upward or downward till he reaches the extremity points A on the y-axis or B on the x –axis. In these cases consumer will choose only one of two goods, depending on his scale of preference and level of satisfaction between good x and good y. In the above diagram A lies on a higher indifference curve than Therefore the consumer will choose only Y and buy OA of commodity Y. It is also noted that consumer is not tangent to the indifference curve at point A .Therefore consumer’s equilibrium cannot be establish at point A . In case of perfect complementary goods ,the shape of the indifference curve have a right –angled .The equilibrium of the consumer cannot be established because only one point of the indifference curve is tangent to the price line AB.
[math]\frac{MU of Good X}{MU of Good Y }[/math] = [math]\frac{Price of Good X}{Price of Good Y}[/math]
1. A.Koutsoyiannis-Modern Microeconomics 2. Stonier & Hague--Economics 3. Samulson- Principles of Economics 4.H.L. Ahjuja- Principle of Economics
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