A consumer consumes only two good x and y whose prices are Rs. 4 and Rs. 5 per unit respectively. If the consumer chooses a combination of the two goods with marginal utility of X equal to 5 and that of Y equal to 4, is the consumer in equilibrium? Give reason. What will a rational consumer do in this situation? Use utility analysis (6 Marks)
Dear Student,
Given, Px = 4 and Py = 5 MUx, = 5, MUy, = 4.
MUx/Px = 5/4 = 1.25
MUy/Py = 4/5 = 0.8
Here, MUx/Px > MUy/Py
Given, Px = 4 and Py = 5 MUx, = 5, MUy, = 4.
MUx/Px = 5/4 = 1.25
MUy/Py = 4/5 = 0.8
Here, MUx/Px > MUy/Py
But the condition of equilibrium is MUx/Px=MUy/Py The consumer is not in equilibrium. The consumer would react to this situation by increasing the consumption of X in place of Y, because of rupee worth of satisfaction in case of X (MUx/Px) is greater than in case of Y(MUy/Py). As consumption of Y is reduced. MUy would start rising. Likewise, increase in the consumption of X would cause a fall in MUx. The process of substituting X for Y would continue till MUx/Px= MUy/Py, when the consumer maximizes his satisfaction.
Regards
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