Question

Does tangency of indifference curve with the budget line always result in optimal solution for the consumer utility maximisation problem?Discuss

Answer 1

Answer:

To maximize utility, a consumer chooses a combination of two goods at which an indifference curve is tangent to the budget line. At the utility-maximizing solution, the consumer's marginal rate of substitution (the absolute value of the slope of the indifference curve) is equal to the price ratio of the two goods

Explanation:

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Answer 2

In a two goods model,the tangency between the indifference curve and the budget line or the tangency condition leads to the utility maximizing situation or optimal choice for any rational consumer.

The tangency condition implies following outcomes:-

• The tangency between the indifference curve and the budget line indicates that the slope of the indifference curve or the Marginal Rate of Substitution(MRS) is the equal to the slope of the budget line or price ratio of the two goods in concern.
• The point of tangency shows that the ratio of Marginal Utility of two goods is equal to the price ratio of both goods which is the utility maximizing condition.
• The tangency point is the most optimal solution for the consumers as at this point the marginal satisfaction obtained by the consumer by purchasing a particular bundle of goods is equal to the marginal cost that he or she is paying to purchase that particular bundle.
• In other words,the willingness of the consumers to exchange the two goods is equal to the rate at which they are sold or traded in the market.