INTRODUCTION:

The main aim of the consumer is consumer is to enjoy maximum level of satisfaction out of a given money income. In order to achieve this objective, he will spend his limited income on a combination of two commodities which yield highest total level of satisfaction. The consumer reaches the position of equilibrium when he enjoys the highest level of satisfaction by consuming the most ideal or best possible combination of two goods for a given amount of income. Consumer’s equilibrium can be explained under Income method, Price effect and Substitution effect.

CONSUMER’S EQUILIBRIUM UNDER INCOME, PRICE AND SUBSTITUTION EFFECT:

• By integrating indifference curve and budget line we can explain consumer equilibrium.

Income effect:-

 it explain as to what happens the consumer equilibrium position when the income of the consumer change while all other determinants of demand remains constant. it measures the change in the amount demanded of the commodity due to the change in real income of the consumer resulting from the change in price. If income of the consumer increases consumer becomes better off and if the consumer’s income falls consumer becomes worse off.

 In the diagram,

• N is the original equilibrium position
• N1 is the new equilibrium position with the rise in income
• N2 is the new equilibrium when income falls.

 If we join N1 and N2 then we get income consumption curve.  The ICC traces the relationship between changes in the level of income and corresponding changes in the level of consumption and the level of equilibrium. Thus when income increases the consumer moves to higher equilibrium position vice versa.

 Price effect:-

 The price effect explained as to what happens to the consumer equilibrium position when the price of one good change whiles the price of another reminder constant. It calculate the changes in quantity demanded of a commodity with a changes in its price. When the price of other commodity remains stable. We also have an assumption that all the other assumption of ICA remains constant.

In the first diagram N is original equilibrium position. N2 is new equilibrium position with a fall in the price of good B. N1 is a new equilibrium position with a rise in price of B. if he joins N2 and N1 we get a price consumption curve which explain the relationship between change and price and the level of consumption. in the second diagram N is the original equilibrium position into the new equilibrium position. N2 is the new equilibrium position with a fall in price of A. fall in a price of A leads to rise in demand for A. N1 is the new equilibrium position with the rise in price of rise in price of A. Rise in price leads to fall in demand for A. if we join N, N2 and N1 we get the price consumption curve which explains the relationship between change and supply in the level of consumption

Substitution effect:

The substitution effect explains that what happened to the consumer equilibrium position and price of both good changes. price of one rises and price of another falls it measured the change in amount demanded of the commodity due to the commodity become cheaper or dearer in relation to demand for another commodities. Cheapness of one good neutralizes the coastline of another good. Hence the total level of satisfaction of the consumer remains the same. Here we assume all other assumption of ICA to hold good.

In the diagram, N is the original equilibrium position at N the consumer is consuming when price of A rises and price of B falls there will be a new budget line P1 and Q1. N is the new equilibrium position on the same indifference curve.

also read: what is price elasticity of demand? explain its types.