# Principles Of Microeconomics

University: Open University Malaysia

PURPOSE

The purpose of this assignment is to enhance learners’ ability to apply the concept of utility to determine its consumer equilibrium.

REQUIREMENT

Select a product of your choice, describe and apply the concepts and theories of utility to the selected product to determine its consumer equilibrium. You have to obtain the market price of the selected product and assume the utils for EACH unit of product consumed. Using a suitable diagram in utility analysis to determine its consumer equilibrium.

Introduction

On the basis of the utility a consumer can choose the product and the consumer will be in equilibrium is the budget of the consumer and the utility level is exactly equal then it can be said that the consumer is in equilibrium. In this case, the budget is the main thing; the consumer will be in equilibrium if the demand of the consumer is backed by the budget of the consumer then the consumer can easily achieve the equilibrium. In this case, one thing can be said that without utility, the consumer will not consume any goods and services and the utility is the diminishing after some certain time (Akın and Platt, 2014). After consuming some certain amount of goods and services, the marginal utility will diminish and it is assumed that the utility can be measured numerically and the level of utility can be identified with the indifference curve. In this case, with the help of the utility level and the budget of the consumer, the consumer equilibrium can be discussed here and the diagrammatical representation of consumer equilibrium will be also there. In this case, two theories are used one is ordinal theory of utility and cardinal theory of utility. In this context, the indifference curve analysis is one of the important thing by which the consumer can be able to achieve the equilibrium. In this case, the slope of the budget line and the slope of the indifference curve will be same. In this case, some assumptions will be there and these assumptions will also be discussed here (Bös, 2014).

Concepts of utility in context to the selected product

A consumer has numerous want and not all the want can give the same level of utility because without the money the consumer will not be able to get the utility of a product. In this case, for example it can be said that a consumer is there who prefers to consume the soft drinks (Choudhari et al. 2015). In this case, the consumer will be able to get utility by consuming the more of more bottles of soft drinks. In this case, the consumer has the purchasing power to buy the soft drinks so it is clear to state the utility of the soft drinks in case of the consumer. In this case, the total utility of the soft drinks will be the summation of the satisfaction of the consumer that the consumer gets from the soft drinks. In this regard, it can be said that after consuming the certain number of bottles of soft drinks the marginal utility will reduce. In this case, the marginal utility means the additional utility that will be gained by the consumer by consuming one additional unit of soft drink. In this context, the total utility is the summation of the marginal utility of the soft drinks of the consumer. In order to understand the total utility and the marginal utility a numeric example will be discussed here;

 Number of bottles of soft drinks consumed by the consumer Total utility of soft drinks Marginal utility of the soft drinks 0 0 - 1 10 10 2 25 15 3 42 17 4 50 8 5 50 0

Table 1: Total and marginal utility of soft drinks

From the table, it is clear that one more bottle of soft drink then the marginal utility will be negative. In this case, the diminishing marginal utility is operating so it is necessary to discuss about the law of diminishing marginal utility.

Figure 1: Diminishing marginal utility

In this case, when the total utility of the consumer is positive that means increasing then the marginal utility is also increasing. When the total utility is reaches at the maximum then the marginal utility is exactly equal to zero and when the total utility is reducing then the marginal utility will be negative. Therefore, the marginal utility will never negative because the consumer will not operate at the diminishing portion of the total utility curve (Debo and Veeraraghavan, 2014).

As a result of the diminishing marginal utility, the demand curve of the soft drinks for the consumer will be negatively sloped because the consumer will buy more units of soft drinks, the marginal utility of that commodity will reduce. Therefore, it can be said that, the consumer will buy less unit of soft drink when the price of the soft drinks will increase. In this context it can be stated that if the price of soft drink reduces then the marginal utility/ price increases. In order to reach at the equilibrium the marginal utility of soft drink must decrease. For marginal utility to decline the consumer must consume more of soft drinks thus the demand of the soft drink will be higher if the price of soft drink will lower (Freeman, Herriges and Kling, 2014).

Utility analysis theory for determining consumer equilibrium

The utility is the basically the satisfaction level of the consumer. In this case, the satisfaction level can give the ordering on the basis of the needs. In this case, the consumer can get the utility if want or the demand of the consumer is backed by the money income (Gul, Pesendorfer and Strzalecki, 2017). Some assumptions are there and on the basis of this the consumer equilibrium can be achieved with the help of the indifference curve analysis. In this case, the assumptions are:

1. The consumers are rational

2. Only two goods X and Y are available for the consumption

3. The prices of the two goods are given

4. The preferences and tastes are same throughout the analysis

5. The consumer prefers more of X to less of Y or more of Y to less of X

6. The indifference curve is negatively slopes

7. The indifference curve is convex to the origin

8. Indifference curve is continues and smooth

Without these assumptions, the consumer equilibrium cannot be achieved and in this case, some properties will also be there for which through the indifference curve analysis the consumer equilibrium can be achieved (Stiglitz and Rosengard, 2015).

In order to achieve the consumer equilibrium, one condition is there that the slope of the budget line will be equal to the slope of the indifference curve (Russo and Tufi, 2016). In this case, the indifference cure is tangent with the budget line when the consumer equilibrium will be achieved.

In this case, with the help of the diagram the consumer equilibrium can be discussed. In this case, the in the horizontal axis the Y goods is measured and on the horizontal axis the X is measured. In this case, AB is the budget line when the slope of the indifference is exactly equal to the slope of the budget line then the consumer equilibrium is achieved. In this case, E is the point of equilibrium.

Figure 2: Consumer equilibrium

At point of E the indifference curve is the tangent with the budget line and at this point the consumer will achieve the maximum level of utility.

On the basis of the properties of the indifference curve, the consumer can be able to earn higher level utility if the consumer can be able to achieve the higher indifference curve (Posner, 2014).

Differences between the Utility analysis theories in determining the consumer equilibrium

In order to achieve the consumer equilibrium the indifference curve analysis is very much needed the utility analysis in this regard two types one is cardinal approach and another one is ordinal approach. Both the approaches are useful to analyze the consumer equilibrium. On the basis of cardinal approaches, the utility can be measured and it is quantifiable. In this case, the consumer can calculate the utility levels of each bucket of the goods. For example it can be said that, the consumer can get 15 unit of utility from the A set of goods, the consumer is getting 25 units of utility while consuming the B sets of goods and 50 unit of utility is getting from the C set of goods and so on (Kauder, 2015). In this case, the consumer can also be able to measure the utility level for each of the goods. In this case, the consumer will be in equilibrium where they get the higher level of utility. In this case, the consumer is also able to say which goods are more preferred than the other goods. For example, it can be said that, A is preferred to B twice or thrice as much as C is preferred to D. However, as a criticism it is clear that, the cardinal approach theory is not appropriate because the utility is the physiological thing and it cannot be measure or quantify. Therefore, it can be said that, the cardinal approach of consumer equilibrium is totally unrealistic (Larson et al. 2014).

On the other hand, the ordinal theory is much more appropriate for the consumer equilibrium analysis. Indifference curve analysis is one of the main parts of the ordinal theory. In this case, the consumer can be able to order that utility because the consumer has much more demand so instead of quantify the utility the consumer can give the ordering to the utility. In this case, one thing can be said that the lexicographic ordering is one of the basic part with which the consumer can give the ordering to the utilities (Subramanian and Rao, 2016). In this case, the consumer can give the ordering on the basis of the needs. If the need of C goods is higher then the utility of those goods will be higher. Apart from this, the indifference curve analysis is another part of the ordinal approach of the consumer equilibrium analysis. According to the indifference curve analysis it is assumed that, the economy is the 2 good economies and with the help of the indifference curve the consumer can measure their utility. The higher and higher indifference curve will give the higher and higher utility. Any point on the indifference curve is shows the same level of utility and one more thing can be said here that two indifference curve cannot be intersect with each other. Therefore, with the help of the indifference curve analysis the consumer will be able to measure the utility level or their satisfaction level (Mak, 2017).

Consumer equilibrium in context to the selected product

In order to discuss the consumer equilibrium theory with respect to utility then it necessary to represent the consumer equilibrium with the help of the indifference curve analysis. In this case, the each and every indifference curve will show the utility level of the soft drinks for the consumer (Nas, 2016). In this case, higher and higher indifference curve will give the higher level of utility and two indifference curves cannot intersect each other. In this case, the budget line is necessary because without money the consumer cannot be able to get the utility from the soft drinks. For example, the budget line is the money income of the consumer and it is assumed that in the economy there are only two goods to consume for the consumer. Therefore, except the soft drinks there is one more thing to consume (Posner, 2014). In this case, the money income will be spent more on the soft drinks because the consumer will get more utility by consuming the soft drinks. In order to achieve the equilibrium the condition for the equilibrium is the marginal utility of soft drink/ price of soft drink. Therefore, it can be said that when the slope of the budget line is exactly equal to the slope of the indifference curve. Once the equilibrium achieved the consumer wants to get the higher utility.

Figure 3: The consumer equilibrium

In this figure, in the horizontal axis, the consumption of the soft drinks will be measured and in the vertical axis, the commodity Y will be measured. AB is the budget line for both the commodities and it is the money income of the consumer. In this figure at point e the slope of the budget line and the slope of the indifference curve is same and at point e the budget line AB is tangent with the indifference curve 2 which is the indifference curve for the soft drinks of the consumer (Russo and Tufi, 2016). In this case, the consumer will attain the indifference curve 3 because the budget of the consumer is much lower and the indifference curve 1 is lower than the budget of the consumer so at indifference curve 3 the consumer will be able to achieve the equilibrium. In this case, if the consumer is able to achieve the indifference curve 3 then the consumer will be able to get the higher utility from the soft drinks (Wu and Huang, 2014). On the other hand, it can be said that if the consumer will operate at the indifference curve 1 then the consumer will be have the extra amount of money to spend so the consumer will achieve the indifference curve 2 which is higher than the indifference curve 1 and it gives the higher utility than the indifference curve 1.

In this case, the consumer will be able to achieve the higher utility if the budget or the money income of the consumer will higher. In addition to that, the consumer will try to maximize the utility with respect to the budget. In this case, money income or the budget of the consumer is the constraint to maximize the utility (Stiglitz and Rosengard, 2015)

Summary

A consumer generally chooses the product on the basis of factor of utility. Consumers are said to be in equilibrium in cases where their budgets and the utility level is exactly equal. The budget is the most important factor for consideration here; a targeted consumer is said to be in equilibrium only if their demands, needs and requirements are backed by the budget that they can afford. Without the aspect of utility, consumers have been noted to not be able to consume any services, goods and services. In this case, the value of utility is said to be diminishing. Following the consumption of a certain amount of services and goods, the marginal utility is said to decrease and diminish. Many have assumed numeric measurement of utility, and the indifference curve has been observed to be one of the main values through which utility level can be identified. Consumer equilibrium as well as its diagrammatical representation has helped in conducting this study in an efficient and effective manner. The Ordinal theory of utility and cardinal theory of utility have demonstrated their usefulness in this regard as well, and have been incorporated in this study. The indifference curve analysis is one of the analytical methods that can be used to help a consumer in achieving equilibrium. The budget line slope as well as the slope of the indifference curve will be same in this case. Certain assumptions have also been made in this study.