Consumer’s Equilibrium (Maximum Satisfaction):

The consumer reaches an equilibrium position i.e., attains maximum satisfaction at the point of tangency between the indifference curve and the price line. This indifference curve is of the highest order in the consumer’s scale of preference within his reach. At equilibrium point (E), the slopes of the indifference curve and the price line are the same. The slope of the indifference curve shows the marginal rate of substitution of X for Y (MRSxy), while the slope of the price line indicates the ratio between the prices of two goods, i.e., in Fig. Thus, at point E, the consumer is in equilibrium, that is,

MRSxy = (Price of X) / (Price of Y)

or, (Δ Y / Δ X) = (Px / Py)

Fig: Consumer’s Equilibrium

At the point R, the MRSxy is greater than the given price ratio. Hence, the consumer will substitute good X for good Y and will come down along the price line PL. He will continue to do so till the MRSxy becomes equal to the indifference curve becomes tangent to the given price line, PL. At point S, the MRSxy is less than the given price ratio. Therefore, it will be to the advantages of the consumer to substitute Y for good X and accordingly move up along the price line (PL) till the MRSxy rises so as to become equal to the given price ratio.

Assumptions:

In the indifference curve approach, the equilibrium position of the consumer is achieved under the following assumptions:

• The consumer has a given indifference curve map exhibiting his scale of preferences for various combinations of two goods, X and Y.
• The consumer has a fixed amount of money to be spent on two goods. He has to spend the whole of his given money on the two goods.
• Prices of goods are given and constant for him.
• Goods are homogeneous and divisible.
• The tastes and preferences of the consumer remain constant.
• The consumer seeks maximum satisfaction.
• Superiority of Indifference Curve Analysis over Marginal Utility Analysis
• Indifference curve analysis adopts ordinal measure of utility in a more realistic way.
• Indifference curve analysis uses the concept of the marginal rate of substitution that is measurable. Moreover, in indifference curve analysis, demand can be analyzed without assuming the constant marginal utility of money.