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The idea of consumer equilibrium can sometimes seem a bit confusing upon first
hearing. This actually happens because it has been explained in such a
complicated manner. The reality is that consumer equilibrium does not need to
be such a complex concept.

Before any attempt to define consumer equilibrium it is important to understand

what is meant by 

. This word utility is used in economics to refer to the
ability of some product or service to satisfy our desires. One of the ideas behind
consumer equilibrium is that humans will buy different products and services in
such a way as to maximize their total utility; in layman͛s terms they will try to get
the best value from their money.

Unfortunately most people are restrained by their income as to how many goods
and services they can buy; they can only create a certain amount of utility. In fact
it isn͛t only income but also other demographic variables that will determine
how many products and services they can buy.

This all means that the individual will need to make choices about what products
and services they buy in an attempt to get the maximum utility. The point at
which a person͛s income is spread in such a way that they could not possibly
increase their utility is referred to as consumer equilibrium.
  


The branch of economics devoted to the study of consumer behavior, especially

as it applies to decisions related to purchasing goods and services through
markets. Consumer demand theory is largely centered on the study and analysis
of the utility generated from the satisfaction of wants and needs. The key
principle of consumer demand theory is the law of diminishing marginal utility,
which offers an explanation for the law of demand and the negative slope of the
demand curve.

Consumer demand theory provides insight into an understanding market

demand and forms a cornerstone of modern microeconomics. In particular, this
theory analyzes consumer behavior, especially market purchases, based on the
satisfaction of wants and needs (that is, utility) generated from the consumption
of a good.

The notion that market demand depends on the satisfaction of wants and needs
has been an essential part of the economic analysis of markets since at least the
time of Adam Smith. However, three scholars working in progression from the
late 1700s to the late 1800s gave the development of consumer demand theory
a large, formal boost.

O? Ñ
   è The first major advance in the development of

consumer demand theory was provided by Jeremy Bentham in the late
1700s. Bentham coined the term "utility" in reference to the satisfaction
of wants and needs. He also developed the notion that people are
motivated by the desire to maximize utility. Bentham firmly believed that
 utility was a measurable, quantifiable characteristic of a person, much
like height or weight.

O? Ñ 
 
è The theoretical work developed by Bentham was
extended and popularized by John Stuart Mill, whose father James Mill
was a contemporary and close friend of Bentham. The elder Mill
introduced the younger Mill to the thoughts and teachings of Bentham at
an early age. John Stuart Mill expanded and promoted these consumer
demand principles in a number of publications, including his book,
Principles of Political Economic, which was the dominate economics
textbook for several decades.

O? D

   Ñ è A major improvement in consumer demand
theory was provided by William Stanley Jevons with the notion of
marginal utility. Jevons also developed the rule of consumer equilibrium,
stating that consumers purchase goods such that the ratio of marginal
utilities is equal to the ratio of prices. Along the way, Jevons helped to
transform consumer demand theory (as well as microeconomics in
general) into a rigorous mathematical science.

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In economics, utility is a measure of relative satisfaction. Given this measure,

one may speak meaningfully of increasing or decreasing utility, and thereby
explain economic behavior in terms of attempts to increase one's utility. Utility is
often modeled to be affected by consumption of various goods and services,
possession of wealth and spending of leisure time.

Utility is an abstract concept rather than a concrete, observable quantity. The

units to which we assign an ͞amount͟ of utility, therefore, are arbitrary,
representing a relative value. Total utility is the aggregate sum of satisfaction or
benefit that an individual gains from consuming a given amount of goods or
services in an economy. The amount of a person's total utility corresponds to the
person's level of consumption. Usually, the more the person consumes, the
larger his or her total utility will be. Marginal utility is the additional satisfaction,
or amount of utility, gained from each extra unit of consumption.

Although total utility usually increases as more of a good is consumed, marginal

utility usually decreases with each additional increase in the consumption of a
good. This decrease demonstrates the law of diminishing marginal utility.
Because there is a certain threshold of satisfaction, the consumer will no longer
receive the same pleasure from consumption once that threshold is crossed. In
other words, total utility will increase at a slower pace as an individual increases
the quantity consumed.

Take, for example, a chocolate bar. Let's say that after eating one chocolate bar
your sweet tooth has been satisfied. Your marginal utility (and total utility) after
eating one chocolate bar will be quite high. But if you eat more chocolate bars,
the pleasure of each additional chocolate bar will be less than the pleasure you
received from eating the one before - probably because you are starting to feel
full or you have had too many sweets for one day.

This table shows that total utility will increase at a much slower rate as marginal
utility diminishes with each additional bar. Notice how the first chocolate bar
gives a total utility of 70 but the next three chocolate bars together increase
total utility by only 18 additional units.

The law of diminishing marginal utility helps economists understand the law of
demand and the negative sloping demand curve. The less of something you
have, the more satisfaction you gain from each additional unit you consume; the
marginal utility you gain from that product is therefore higher, giving you a
higher willingness to pay more for it. Prices are lower at a higher quantity
demanded because your additional satisfaction diminishes as you demand more.

In order to determine what a consumer's utility and total utility are, economists
turn to consumer demand theory, which studies consumer behavior and
satisfaction. Economists assume the consumer is rational and will thus maximize
his or her total utility by purchasing a combination of different products rather
than more of one particular product. Thus, instead of spending all of your money
on three chocolate bars, which has a total utility of 85, you should instead
purchase the one chocolate bar, which has a utility of 70, and perhaps a glass of
milk, which has a utility of 50. This combination will give you a maximized total
utility of 120 but at the same cost as the three chocolate bars.

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The process or goal of obtaining the highest level of utility from the consumption
of goods or services. The goal of maximizing utility is a key assumption
underlying consumer behavior studied in consumer demand theory. Consumers
are assumed to make choices, especially concerning the purchase of goods, such
that they obtain the highest possible level of satisfaction. Utility maximization
can be achieved at the peak of the total utility curve.

Utility maximization is the guiding notion underlying consumer choices analyzed

with consumer demand theory and utility analysis. It makes sense to think that
people are generally motivated to do what is best for them, to purchase the
most satisfying goods, to make the decisions that do more good than harm, to
improve their overall living standards and well-being, that is, to maximize their
utility.

Working through the logical consequences of this assumption, when combined

with other principles of consumer behavior especially the law of diminishing
marginal utility, makes it possible to gain insight into such things market demand
and the law of demand.

The utility maximization goal is based on the seemingly obvious presumption

that people prefer more to less. This presumption is tied to the unlimited wants
and needs aspect of scarcity. In other words, because people have unlimited
wants and needs, satisfying those wants and needs is a desirable thing to do.
Someone like Duncan Thurly would rather have a full belly than an empty one.
He would rather live in a cozy, climate-controlled house than in a cardboard box
under a bridge.

Of course, if wants and needs are unlimited, can anyone actually maximize
utility? That is, can Duncan ever achieve the absolute pinnacle of satisfaction?
Can he actually maximize utility? In terms of the scarcity problem, probably not.
He might be able to boost utility a little higher by satisfying another unfulfilled
want or need. But he is unlikely to maximize utility totally and completely. This is
one reason why it is reasonable to think of utility maximization as a process of
seeking what is ultimately unreachable.

However, in the analysis of consumer demand theory, utility maximization has a

more pragmatic interpretation--obtaining the highest possible satisfaction from
consuming a given good or undertaking a specific activity. While Duncan might
not be able to maximize his OVERALL utility, he can maximize the utility obtained
from eating Hot Momma Fudge Bananarama Ice Cream Sundaes. It is this
pragmatic interpretation of utility maximization that pervades the study of
economics.






The accompanying table can be used to illustrate utility

maximization. The numbers indicate the total utility obtained by
Edgar Millbottom while riding the Monster Loop Death Plunge
roller coaster at the Shady Valley Amusement Park. The right-
hand column is the accumulated satisfaction Edgar receives from
riding the Monster Loop Death Plunge roller coaster 8 times
during his day at the amusement park.

The numbers indicate that Edgar receives the greatest total utility, 36 utils, by
riding the Monster Loop Death Plunge roller coaster 6 times. Taking 5 trips
around the Monster Loop Death Plunge roller coaster track generates only 35
utils. Likewise, 7 rides generate only 35 utils. Maximum utility comes from 6
rides and only 6 rides. Anything else comes in less.

Utility maximization can be visually

identified with a total utility curve,
such as the one presented in this
exhibit. In this case the maximum level
of utility obtained by Edgar riding the
Monster Loop Death Plunge roller
coaster is relatively obvious. The total
utility curve reaches its highest point
for 6 roller coaster rides. The curve
increases up to the sixth ride, then declines for subsequent rides.

In the real world, the goal of utility maximization often encounters obstacles that
prevent obtaining the highest overall level of utility. In many circumstances,
consumers are unable to reach the peak of the total utility curve. Under these
circumstances, consumers face a constrained utility maximization.

The constraints could be physical or legal. For example, Edgar might not be able
to ride the Monster Loop Death Plunge roller coaster 6 times because a bolt of
lightning struck the track destroying a large section or perhaps the Shady Valley
Amusement Park obtained a court order preventing Edgar for entering the park.
However, the constraints facing most consumers most of the time are economic-
-that is, they have limited income and cannot afford to buy as much of a good as
they want. If Edgar is charged Rs. 1 per ride and has only Rs. 5 of cash, then he is
not able to achieve the utility maximizing 6 rides.
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When consumers make choices about the quantity of goods and services to
consume, it is presumed that their objective is to maximize total utility. In
maximizing total utility, the consumer faces a number of constraints, the most
important of which are the consumer's income and the prices of the goods and
services that the consumer wishes to consume. The consumer's effort to
maximize total utility, subject to these constraints, is referred to as the
consumer's problem. The solution to the consumer's problem, which entails
decisions about how much the consumer will consume of a number of goods and
services, is referred to as consumer equilibrium.











Consider the simple case of a consumer who cares about consuming only two
goodsè good 1 and good 2. This consumer knows the prices of goods 1 and 2 and
has a fixed income or budget that can be used to purchase quantities of goods 1
and 2. The consumer will purchase quantities of goods 1 and 2 so as to
completely exhaust the budget for such purchases. The actual quantities
purchased of each good are determined by the condition for consumer
equilibrium, which is,

This condition states that the marginal utility per Rupee spent on good 1 must
equal the marginal utility per Rupee spent on good 2. If, for example, the
marginal utility per Rupee spent on good 1 were higher than the marginal utility
per Rupee spent on good 2, then it would make sense for the consumer to
purchase more of good 1 rather than purchasing any more of good 2. After
purchasing more and more of good 1, the marginal utility of good 1 will
eventually fall due to the law of diminishing marginal utility, so that the marginal
utility per Rupee spent on good 1 will eventually equal that of good 2. Of course,
the amount purchased of goods 1 and 2 cannot be limitless and will depend not
only on the marginal utilities per Rupee spent, but also on the consumer's
budget.

 

To illustrate how the consumer equilibrium condition determines the quantity of

goods 1 and 2 that the consumer demands, suppose that the price of good 1 is
Rs. 2 per unit and the price of good 2 is Rs. 1 per unit. Suppose also that the
consumer has a budget of Rs. 5. The marginal utility (MU) that the consumer
receives from consuming 1 to 4 units of goods 1 and 2 is reported in Table 1 .
Here, marginal utility is measured in fictional units called utils, which serve to
quantify the consumer's additional utility or satisfaction from consuming
different quantities of goods 1 and 2. The larger the number of utils, the greater
is the consumer's marginal utility from consuming that unit of the good. Table 1
also reports the ratio of the consumer's marginal utility to the price of each
good. For example, the consumer receives 24 utils from consuming the first unit
of good 1, and the price of good 1 is Rs. 2. Hence, the ratio of the marginal utility
of the first unit of good 1 to the price of good 1 is 12.
The consumer equilibrium is found by comparing the marginal utility per Rupee
spent (the ratio of the marginal utility to the price of a good) for goods 1 and 2,
subject to the constraint that the consumer does not exceed her budget of Rs. 5.
The marginal utility per Rupee spent on the first unit of good 1 is greater than
the marginal utility per Rupee spent on the first unit of good 2(12 utils > 9 utils).
Because the price of good 1 is Rs. 2 per unit, the consumer can afford to
purchase this first unit of good 1, and so she does. She now has Rs. 5 о Rs. 2 = Rs.
3 remaining in her budget. The consumer's next step is to compare the marginal
utility per Rupee spent on the second unit of good 1 with marginal utility per
Rupee spent on the first unit of good 2. Because these ratios are both equal to 9
utils, the consumer is indifferent between purchasing the second unit of good 1
and first unit of good 2, so she purchases both. She can afford to do so because
the second unit of good 1 costs Rs. 2 and the first unit of good 2 costs Rs. 1, for a
total of Rs. 3. At this point, the consumer has exhausted her budget of Rs. 5 and
has arrived at the consumer equilibrium, where the marginal utilities per Rupee
spent are equal. The consumer's equilibrium choice is to purchase 2 units of
good 1 and 1 unit of good 2.

The condition for consumer equilibrium can be extended to the more realistic
case where the consumer must choose how much to consume of many different
goods. When there are N > 2 goods to choose from, the consumer equilibrium
condition is to equate all of the marginal utilities per Rupee spent,

subject to the constraint that the consumer's purchases do not exceed her
budget.