Answer to Question #182951 in Microeconomics for Noor

Question

A consumer has preferences over two goods, coconuts and fish. The consumer prefers more of each good to less and has a diminishing marginal rate of substitution between the two goods. Draw a diagram showing indifference curves and the budget constraint of the consumer. Explain how the optimal consumption choice is found.

Answer 1

An Indifference curve shows the combinations of two goods between which the consumer regards as of equal value

Budget line is a constraint beyond which the consumer cannot spend. 

The graph below shows the indifference curve and budget line given two commodities; fish and coconut.

MN represents the budget line and ICs show the indifference curves. 

Due to diminishing marginal rate of substitution, the indifference curve is convex. 

The consumer is on D, he is utilising his income but is on a lower indifference curve. 

If the consumer moves to point E, he will still be on the budget line but on a higher indifference curve and a higher indifference curve gives higher satisfaction.

point C is unattainable as the consumer's income is less than the level of C. 

The consumer's equilibrium would be at E where the indifference curve is tangent to budget line ie the slope of indifference curve is equal to that of budget line