Optimal Choice of Consumer
•The budget set consists of all bundles that are available to the consumer.
•The consumer can choose her consumption bundle from the budget set.
•In economics, it is assumed that the consumer is a rational individual who chooses her consumption bundle on the basis of her taste and preferences over the bundles in the budget set.
•Between any two bundles, she either prefers one to the other or she is indifferent between the two.
Assumption of Rational thinking
•A rational individual clearly knows what is good or what is bad for her, and in any given situation.
•Here decisions are not based on emotional but rational thoughts and she always tries to achieve the best for herself.
•It is thus assumed that not only does a consumer have well-defined preferences over the set of available bundles, she also acts according to her preferences.
•From the bundles which are available to her, a rational consumer always chooses the one which gives her maximum satisfaction.
The consumer’s problem
•A budget set describes the bundles that are available to the consumer and her preferences over the available bundles can usually be represented by an indifference map.
•The rational consumer’s problem is to move to a point on the highest possible indifference curve given her budget set.
Finding the Optimum Point
•The optimum point would be located on the budget line.
•A point below the budget line cannot be the optimum.
•If the consumer’s preferences are monotonic, for any point below the budget line, there is some point on the budget line which is preferred by the consumer.
•Points above the budget line are not available to the consumer.
•Therefore, the optimum (most preferred) bundle of the consumer would be on the budget line.
Where on the budget line will the optimum bundle be located?
•The point at which the budget line just touches (is tangent to), one of the indifference curves would be the optimum.
•Any point on the budget line other than the point at which it touches the indifference curve lies on a lower indifference curve and hence is inferior.
•Therefore, such a point cannot be the consumer’s optimum.
•The optimum bundle is located on the budget line at the point where the budget line is tangent to an indifference curve.
•The indifference curve just touching the budget line is the highest possible indifference curve given the consumer’s budget set.
•Bundles on the indifference curves above this, like the grey one, are not affordable.
•Points on the indifference curves below this, like the blue one, are certainly inferior to the points on the indifference curve
•Therefore, th point (x*1, x *2 ), at which the budget line is tangent to an indifference curve represents the consumer’s optimum