Which of the following indicates a situation of consumer's equilibrium for a rational consumer consuming two goods?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → The point at which the budget line just touches (is tangent to), one of the indifference curves.
At consumer’s equilibrium, the budget line is tangent to the indifference curve, showing that the marginal rate of substitution (MRS) between the two goods is equal to the ratio of their prices (Px/Py). This means the consumer maximizes satisfaction given income and prices.
The other options are incorrect because:
-
If MRS > price ratio, the consumer can still increase satisfaction by changing the consumption bundle.
-
A point below the budget line: This point is attainable but does not utilize the consumer's entire income. Since a rational consumer aims to maximize utility, they will always move to a point on the budget line to reach a higher indifference curve.
-
If the budget line intersects the indifference curve, it’s not equilibrium since a higher indifference curve can still be reached.