question_answer

Explain the condition of consumer's equilibrium using indifference curve analysis.

Answer:

Consumer's equilibrium using indifference curve analysis ? According to indifference curve analysis, a consumer attains equilibrium at a point where budget line is tangent to indifference curve. Consumer equilibrium is achieved where slope of indifference curve (MRS) = slope of budget line (\[Px/Py\])

MRS = \[Px\div Py\](Ratio of prices of two goods)

Given the indifference map (preference schedule) of the consumer and budget or price line, we can find out the combination which gives the consumer maximum satisfaction. The aim of the consumer is to obtain highest combination on his indifference map and for this he tries to go to the highest indifference curve with his given budget line. He would be in an equilibrium only at such point which is common point between budget line and the highest attainable indifference curve. A consumer is in equilibrium at a point where budget line is tangent to indifference curve. At this point, slope of indifference curve (called MRS) is equal to slope of budget line.

In the above fig, P is the equilibrium point at which budget line M just touches the highest attainable indifference curve\[I{{C}_{2}}\]within consumer budget. Combinations on \[I{{C}_{3}}\] are not affordable because his income does not permit whereas combinations on \[I{{C}_{1}}\] gives lower satisfaction than\[I{{C}_{2}}\]. Hence, best combination is at point P where budget line is tangent to the indifference curve\[I{{C}_{2}}\]. It is at this point that consumer attains the maximum satisfaction at the state of equilibrium.

For consumer's equilibrium, two conditions are necessary:

(a) Budget line should be tangent to indifference curve (MRS = Px/Py).

(b) Indifference curve should be convex to the point of origin (i.e., MRS should be diminishing at a point of equilibrium.)