The term equilibrium can be mildly misleading when used in economics. While the basic definition remains consistent (equilibrium exists when a state of balance is created between forces), the applications of the term have a funny way of glossing over the human element involved.
Take consumer equilibrium, for example. Sounds like a nice position to be in, doesn’t it? Admittedly, it is, at least to a certain extent. The fly in the ointment is that it applies to “consumers” with low incomes (so at least something is not in equilibrium). But this very fact makes consumer equilibrium a fascinating subject. Check out the definition and examples below and learn in tandem with this five-star course on predicting consumer decisions.
What Is Consumer Equilibrium?
The simplest, shortest way of defining consumer equilibrium is this: it exists when a consumer is completely satisfied with a product based on the price:value ratio. In other words, the price of food might hover around consumer equilibrium, which in turn prevents consumers from rioting in the streets.
There is definitely an element of psychology involved in consumer equilibrium. For example, a consumer might only have $150 a month to spend on food, but if the consumer can satisfy his or her needs completely, then equilibrium is achieved by the prices of the products he or she purchases, as well as their quantities.
You can see how consumer equilibrium cannot possibly apply to the very wealthy because money is, quite literally, not an issue. The difference between a $200 and $400 grocery bill is not cause for concern if you can afford both with the same relative ease.
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I Can’t Get No (Satisfaction)
The key to consumer equilibrium is satisfaction, which again eliminates the wealthy from this category (not that the wealthy are incapable of satisfaction, of course). Consumer equilibrium primarily exists not just when basic human needs are met (food, shelter, etc.), but when the consumers are truly satisfied. This satisfaction is of the utmost importance. Why? Because it means that the producer of the goods can continue to charge a steady price without fear of consumers going elsewhere for a similar product.
And again, a wealthy person’s satisfaction does not hinge on the difference between a $1.99 bottle of dish soap and a $3.99 bottle of dish soap. Understanding consumer equilibrium is vital for companies so that they can know when consumers are happy in their habits; it is human nature to settle into a routine, and as long as the price to value ratio gives us satisfaction, we are happy to direct our worries elsewhere.
If you want to learn how to predict and understand price fluctuations, read this great blog post on the Consumer Price Index (CPI) formula.
The Brains Behind The Operation: Example #1
A consumer with limited income cannot spend money freely. Every product costs a certain amount of money, and only X number of products can be purchased until income becomes unbalanced by expenditures.
Thus, a consumer who possesses any degree of forethought tries to achieve balance by getting the most for his or her money. The belief of consumer equilibrium is that the consumer is satisfied once this balance is achieved. It is also believed that the consumer is aware of all of his or her options, knows the different price:value ratios available, and understands exactly why he or she is making certain purchases.
I have been writing as if consumer equilibrium applied to single products, so let us use this as our first example.
A consumer reaches equilibrium with a single product when he or she can comfortably purchase enough of the product to achieve satisfaction. This depends on two things: price per unit and the amount of utility the consumer gets per unit.
Interestingly, each of us decides our own consumer equilibrium any time we compare products. We look at price, price per unit, price vs. quality, etc. Utility is completely subjective and also dependent on income (among other things). It is therefore impossible to determine a universal consumer equilibrium.
An Unexpected Deal
So what happens when equilibrium is not achieved because the price is too low? It depends completely on what the product is. If it is, say, a kitchen sponge than it is not likely that the consumer is going to go on a spending spree. But if Hagen Dazs started selling it’s personal 4 oz. ice-cream cartons for ten cents each, then I know that I, for one, would probably buy $5 worth (the approximate price of a half-gallon of ice cream). But neither situation is ideal for the producer of the product because the profit margins would be low, and for absolutely no reason whatsoever.
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Two Or More Products: Example #2
There’s a lot of technical theory I don’t have the space to explain, but this is probably a good thing because the discussion of what’s happening is exactly the same.
In the first example, we assumed that the consumer was only interested in one product. This will almost never be the case. Instead, a consumer spends his or her income on an enormous variety of products. This example takes two or more products into account.
I had spoken earlier about the price:value ratio (known in economics as Price:Marginal Utility). Now, the exact numbers between two or more products obviously do not need to be the same. That would be uncanny. But the ratios do need to match, which makes sense if you think about it. Because someone’s income does not change depending on the product they are considering, then neither should their judgment of price:value.
Thrown Off Balance
The obvious scenario that would cause a problem is when the ratios of two products are not equal. If the products are similar, bagels vs. bread, then the commodity that has the better ratio is likely to be purchased in greater quantities (at least, until the consumer spends all of his or her allotted money on the “bread” category). Even if the products are not similar, however, the product with the better price:value ratio is still going to be favored for purchase. Get your hands on powerful strategy insights with this business strategy course on how to win in an unpredictable world.
Let’s say a slice of bread costs $1 and a bagel costs $1.75. A consumer, at first, desires to purchase the slice of bread. This will give them the most value for their money. But after purchasing, say, six slices of bread, the consumer is no longer getting satisfaction from the bread. The value of the bread, then, has greatly decreased. The consumer will then add bagels to his or her shopping cart. These are more expensive, so after three bagels the consumer decides enough is enough.
In this case, the bread was, in fact, purchased in greater quantities, but only until the product lost its value (you can only east so much bread, after all). But the bagels lost their value because they were too expensive (I’d love to eat more bagels, but it’s not worth the price). In this case, equilibrium exists when the consumer buys six units of bread ($6.00) and three units of bagels ($5.75). Both reach a price:value equilibrium, but for different reasons.
Beating The System
Of course, you can “beat the system” by increasing the value of a product in the customer’s eyes. This is achieved through marketing, advertising, etc. This top-rated course on using marketing research for profit provides a step-by-step guide to capitalizing on your market.