Question

What are the assumptions of the budget line? Of the Production Possibilities Model? Highlight the similarities and differences?

Answer 1

Assumptions of budget line:

Income is fixed

Prices of goods are fixed

Complete income is to be spent on the given goods

The chosen combination should lie on the budget line

The assumptions of the production possibilities model are:

1. Resources are used to produce one or both goods

2. Quantity of resources are fixed

3. Technology is fixed

4. Resources are used in technologically efficient model

5. The optimal consumption occurs at the point of tangency of budget line and indifference curve

Similarities:

Only two goods taken into account

Prices are fixed

Optimal point lies on budget line

Difference:

Technology not taken into account in case of budget line

PPF takes into account utility but budget line does not