Consumer's Equilibrium

A consumer achieves equilibrium when given his income and prices of the goods he consumes, he maximizes his utility or satisfaction. That is, when he reaches highest indifference curve possible with his budget line. In the figure the consumer is in equilibrium at point H when he consumes 100 units of food and purchases 5 units of clothing. The budget line AB is tangent to the highest possible indifference curve at point H.

The slope of the indifference curve and budget line are equal at the tangency point We know that:

• the slope of the indifference curve depicts the marginal rate of substitution of clothing (y) for food (x) (MU_y / MU_x).

• the slope of the budget line indicates the ratio between the prices of two goods (P_y/ P_x).

Therefore at equilibrium point H

P_y/P_x=MU_y/MU_x= MRS_yx

The consumer is in equilibrium at point H as MRS_yx = P_y/P_x· He is on the highest possible indifference curve given budgetary constraint and prices of two goods. It should be noted that Rand S are also tangency points but they are on a lower indifference curve I₁ therefore they are not selected. 

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