Using Figure explain why the point of tangency of the budget line with an indifference curve is the consumer’s equilibrium position. Explain why any point where the budget line intersects an indifference curve is not equilibrium. Explain: “The consumer is in equilibrium where MRS = PB/PA.”
Budget line represents all possible combination of two goods on which a consumer spends all his income at given market price. The slope of the budget line is the price ratio.
Indifference curve is a locus of all possible combination of two goods whose consumption provides the individual same level of satisfaction. The slope of the indifference curve is the marginal rate of substitution which is the rate at which consumer is willing to give up one good in order to consume an extra unit of other good.
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