How the Law of Diminishing Marginal Utility Can be Used to Explain the Consumer’s Equilibrium?
So, he goes on consuming the commodity till extra units of the commodity give him some satisfaction. He stops the consumption of the commodity at the point of satiety, i.e., where marginal utility is equal to zero. In Fig. 4.3 (a), this happens at point ‘e’.
Fig. 4.3: Consumer Equilibrium (one Commodity)
When a consumer pays price for the commodity he is consuming, he compares the utility he derives from the additional unit of commodity with the utility he sacrifices in terms of the price paid for that unit of commodity.
Thus, the consumer is in equilibrium, when marginal utility and price are equal. In Fig. 4.3 (b), the consumer is in equilibrium at point ‘E’, where MU =P and he consumes OQ units of the commodity. If he decides to consume less (say, OR units) or more (say, OS units), there will be net loss of total utility in both these situations indicated by shaded areas GEF and HEI respectively in the figure. In the first case, the marginal utility, the consumer will get is higher than the price he pays.
Here, he can buy additional units of GE as for all these extra units; the price he pays is less than the utility he gets. Hence, the consumer will not get maximum net total utility APE (total utility OAEQ – total expenditure OPEQ). Similarly, it can be shown that in the second case, net total utility of the consumer will be less than maximum by disutility indicated by shaded area HEI (additional total expenditure QEHS – additional total utility QEIS).
We observe that at consumer equilibrium, net total utility of the consumer is maximum. At this point, utility obtained from the last unit of the commodity is equal to price paid for the commodity.
At equilibrium, price = marginal utility. This equilibrium condition can be extended for a price less commodity by treating price equal to zero. So, for a priceless commodity, the consumer equilibrium condition gets reduced to marginal utility equal to zero.