question_answer

Draw a diagram indicating the following situations:

(i) \[xy>\frac{Px}{Py}\]

(ii)\[xy=\frac{Px}{Py}\]

(iii)\[xy<\frac{Px}{Py}\]

Where,\[xy\]=Marginal Rate of Substitution of Good \[x\]for Good y  \[{{P}_{x}}\]= Price of Good\[X\], \[{{P}_{y}}\]= Price of Good \[y\]                                                     Which of the three indicates highest level of consumer's satisfaction? A consumer consumes only two goods X and Y. State and explain the conditions of consumer's equilibrium with the help of utility analysis,                                        

Answer:

Graph showing relation between MRS and \[\frac{{{P}_{x}}}{{{P}_{y}}}\]at different points on indifference curve The point where\[MR{{S}_{xy}}=\frac{{{P}_{x}}}{{{P}_{y}}}\]indicates the highest level of consumer's satisfaction i.e. E is the point of maximum consumer satisfaction (or consumer equilibrium).                                     Or  The two conditions of consumer's equilibrium are stated below:                                                       (i) Ratio of Marginal Utility to Price of Two Goods are Equal to Marginal Utility of Money This condition can be expressed as     \[\frac{M{{U}_{x}}}{{{P}_{x}}}=\frac{M{{U}_{y}}}{{{P}_{y}}}=M{{U}_{M}}\]             Or \[\frac{M{{U}_{x}}}{M{{U}_{y}}}=\frac{{{P}_{x}}}{{{P}_{y}}}[if\,M{{u}_{M}}=1]\] where,\[M{{U}_{x}}\]and\[M{{U}_{y}}\]= Marginal Utilities of good X and good Y respectively \[{{P}_{X}}\]and\[{{P}_{y}}\]= Price of good X and good Y respectively \[M{{U}_{M}}\]= Marginal utility of money                                             (ii) MU Falls as Consumption Increases If Marginal Utility (MU) does not fall as consumption increases the consumer will end up buying only one good which is unrealistic and the consumer will never reach the equilibrium position.