A consumer tries to achieve maximum satisfaction with his limited Budget. Now to know his equilibrium i.e., maximum satisfaction, we have to combine ICs with the Budget line. Assumptions of Consumer Equilibrium:
- Income of consumer remains constant.
- Consumer behaves rationally and he tries to get maximum satisfaction from his limited income.
- Prices of commodities remain constant.
- Consumer is aware of the indifference map.
- All goods are homogeneous and divisible.
- The condition of transitivity is satisfied i.e., if combination A >B, and B>C, then A>C.
- The condition of non-satiety holds good. The consumer either prefers one of the products or both the products equally
The consumer is said to be in equilibrium when his budget line is tangent to the Indifference curve. This can be explained with the help of the following diagram.
In the above diagram, PQ is budget line. IC1, IC2, and IC3 are Indifference curves. At point ‘E’, the budget line is tangent to Indifference curve IC2,.
The consumer has attained his optimal choice at point E where he buys OM quantity of product x and ON quantity of product y within his budget to get maximum satisfaction. If he selects point below E, he is wasting his money income and the combinations above this are point are not possible as his income is not sufficient. At Point E, the Budget line and IC2 tangent. This can be expressed as follows:
\(\frac{p_x}{p_y}=\frac{MU_x}{MU_x}\)
That means the willingness to substitute is equivalent to the ability to pay. So, a consumer is said to be in equilibrium if his budget line is tangent to IC or when the MRS is equal to the price ratio of the-two goods, PQ is the budget line.
The points other than E are not equilibrium points. For instance, Points A and D are not equilibrium points of consumer as they lie above the budget line. The points B and C lie in IC1, which gives him lower satisfaction for the same budget. Hence, the consumer attains equilibrium only at point E.
