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(B) Equilibrium and the Law of Demand: Once the law of marginal utility is granted, both, the equilibrium of a consumer and the law of demand follow automatically. The equilibrium rule is that the consumer must equate marginal utility with market price of a good in order to maximize his satisfaction. In the example above,

Mu = Price for Maximum satisfaction

If the price of a good (consider a chocolate), is 40 cents per unit then the consumer can buy one unit since,

Mu1 = 40 = price

When the market price is 30, he can buy 2 units and, at market price 18, he can buy 3 units since,

Mu2 = 30 = price

Or, Mu3 = 18 = price

Variations in the number of units consumed at varying prices help to establish the law of demand. As the price of a good falls from 40c to 2c the demand for that good rises from 1 to 5. On the other hand, as the price of a good rises from 1c through 20c the demand for that good goes on falling from 5 through 1. Therefore the inverse relationship between price and quantity of a good demanded at once follows, once the DMU principle is accepted and applied.

(C) Law of Equimarginal Utility: The principle of diminishing marginal utility brings about the law of demand simply by equating market price with marginal utility. If a consumer stops consuming earlier and purchases a unit less than the equilibrium units, then his marginal utility will exceed market price. He has therefore not yet maximized his utility. If he purchases more units than the quantity at equilibrium, then his marginal utility will fall short of the market price and his total utility will be smaller than that at equilibrium, as compared to his total expenditure.

The DMU principle is applicable only in the case of a single commodity. In reality a consumer has to purchase multiple goods. He has therefore to compare the marginal utilities of all such goods that he purchases with the relative prices of these goods. With the limited income that the consumer possesses he may not be able to reach the point of equality between marginal utility and price of each commodity. He may have to stop before such a point is reached and start spending on some other good. How a consumer can attain equilibrium in such a situation is an important question that arises at this point. Even here in the case of multiple goods, the marginal utility principle remains applicable but in a different form. It is called the equimarginal utility principle. What the consumer now attempts is to equate the marginal utility of various goods that he intends to purchase. Since the goods have different prices, the consumer has to equate the ratios of marginal utility and price of all the goods that he desires to purchase. If X, Y, Z etc. are the goods and Px, Py, Pz etc. are their prices respectively then the equilibrium rule can be stated as,

For utility maximization

Index

8.1 Theory Of The Consumer
8.2 Equilibrium Of a Consumer

Chapter 9

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