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Economics · Ch 2 — Consumption Analysis

Consumer's Equilibrium Under the Indifference Curve Approach

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Consumer's Equilibrium Under the Indifference Curve Approach

The two building blocks above — the indifference map (showing what the consumer would LIKE) and the budget line (showing what he can AFFORD) — combine to determine the consumer's actual equilibrium purchase. A rational consumer aims to reach the HIGHEST possible level of satisfaction that his income permits; graphically, this means reaching the highest indifference curve that his budget line still allows him to touch.

Figure 3 — Consumer's equilibrium: the budget line tangent to indifference curve IC2 at point E, with IC1 (cut by the budget line at two points) and IC3 (unreachable, lying entirely outside the budget line) also shown
Figure 3 — Consumer's equilibrium: the budget line tangent to indifference curve IC2 at point E, with IC1 (cut by the budget line at two points) and IC3 (unreachable, lying entirely outside the budget line) also shown

The consumer's equilibrium is reached at the point where the budget line is exactly tangent to an indifference curve — the highest one it can reach. At this tangency point, the slope of the indifference curve (which is MRSxyMRS_{xy}) exactly equals the slope of the budget line (the price ratio PxPy\dfrac{P_x}{P_y}):

MRSxy=PxPyMRS_{xy} = \dfrac{P_x}{P_y} …

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