Question

Why is the consumer in equilibrium when he buys only that combination of the two goods that is shown

at the point of tengency of the budget line with an indifference curve? Explain.​ (for 5 marks)

Answer 1

Explanation:

Let the two goods be X and Y as shown in the diagram. The tangency is at point E where slope of indifference curve = slope of budget line or MRS xy =Px/py The equilibrium purchase is OX of X and OY of Y on the indifference curve I2 level higher than I2 because his income does not permit him to move above the budget line AB. The consumer will not like to purchase any other bundle on the budget line AB. For example the bundle of C and D because they all lie on the lower indifference curve and give him lower satisfaction. Therefore the equilibrium choice is only of the tangency point E