The consumer is in equilibrium when they maximise their satisfaction subject to the income, price and taste and preferences. The consumer is in equilibrium at the point of tangency of the budget line with the highest possible indifference curve (IC).
IC shows the locus of a combination of two goods that gives the same level of satisfaction to the consumer. The consumer is indifferent between any points throughout the IC. Hence it is also called iso-utility curve. Budget line is the locus of combinations of two goods that the consumer can purchase with the given income and price of the goods. It determines the commodities that are affordable to the consumers, given the income and prices.
The equilibrium is determined by the point of tangency between the indifference curve and the budget line. It shows the preferences attainable to the consumer by taking the constraints imposed by other factors into consideration.
The objective of every rational consumer is to maximise satisfaction. With the constraints imposed by income and prices, the consumer aims to achieve the highest possible utility. This occurs at the point of tangency of the indifference curve with the budget line.
The consumer is in equilibrium at the point of tangency of the indifference curve (IC) with the budget line. IC1, IC2 and IC3 are the indifference map depicting the preferences of the consumers. CH is the budget line depicting the constraints imposed though income and prices. The consumer is in equilibrium at E where the IC2 is tangent with the budget line CH. Since the lower IC represents a lower level of satisfaction, IC1 will not be considered by the consumer. IC3 will not be considered as it remains unattainable as it is beyond the resources of the consumer. Thus, the consumer will remain at IC2.
At the equilibrium point, the slope of the IC will be equal to the slope of the budget line. The slope of the IC is the Marginal Rate of Substitution (MRS). The slope of the budget line is the price ratio. Thus at the point of equilibrium, the MRS would be equal to the price ratios.
MRSxy = Px/Py
Thus at equilibrium, the budget line would be tangent to the highest possible IC. This ensures the equality of the Marginal Rate of Substitution with the price ratios.
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