Microeconomics Class 4: Optimal Choice and MRS

Study Notes

Optimal consumption is determined by indifference curves (ICs) and budget constraints (BCs).
Consumer behavior is based on optimization.
The optimum occurs where the indifference curve is tangent to the budget line.
The slope of the budget constraint is determined by prices.
At the optimum, the slope of the indifference curve (MRS) equals the slope of the budget line. The MRS represents the rate at which a consumer is willing to trade one good for another while maintaining the same level of satisfaction.

Indifference curves show combinations of goods that provide equal utility to a consumer.
Budget constraints represent all possible combinations of goods a consumer can afford given their income and prices.
A consumer chooses consumption bundles that maximize their utility given their budget constraint.

At the optimum, the indifference curve is tangent to the budget line.
This means the slopes of the indifference curve and budget constraint are equal.

The slope of the indifference curve (MRS) must equal the negative of the price ratio for the consumer to maximize utility
Δx₂ / Δx₁ = p₁ / p₂

An increase in income shifts the budget constraint outward, increasing the options available to the consumer.
The new optimum is on a higher indifference curve than the previous one.
In most cases, consumption of both goods rises(normal goods)
With an inferior good, consumption decreases with income rise

An increase in the price of good 1 reduces the consumer's purchasing power, shifting the budget line inward. The new optimum is on a lower indifference curve than the previous one.
Consumers reduce the consumption of the good whose price has risen(ordinary goods).
A Giffen good is an exceptional case in which consumer demand increases with rising price.

Consumer choice is determined by indifference curves and budget constraints.
The optimal point is where the indifference curve is tangent to the budget constraint.