Question

Suppose that in consumer equilibrium this individual consumes 7 pizza and 6 coke. What rules must hold in consumer equilibrium? Label this bundle in your drawing (call it point “A”).

Answer 1

Solution:

Derive the budget line:

Budget line: M = PxX + PyY

Where: M = Income = 1000

       X = pizza 

       Y = coke

       Px = Price of pizza = 100

       Py = Price of coke = 50

Income = 1000

Therefore, the budget line is as follows:

M = PxX + PyY

1000 = 100X + 50Y

Consumer equilibrium is at the point where consumers maximize their consumption at a point where the budget line is tangent to only one indifference curve when both the conditions of consumers are satisfied. These conditions are as follows:

1.). MRS = Ratio of prices or PX/PY

2.). MRS continuously falls.

This is depicted by the below graph: