Question

1. 
   (25’) The utility-maximizing bundle of goods is found at the point of tangency between the budget constraint and an indifference curve. In the following diagram, the utility-maximizing bundle is the one labeled point K. There are two different, but equally important, ways to interpret this point.

1. Of the three points on the consumer’s budget constraint (J, K, and L), what makes K special?

2. Of the three points on the consumer’s indifference curve (M, K, and N), what makes K special?

Answer 1

a. K is the point of optimization where slope of the indifference curve is equal to the slope of the budget line. At the point of optimization, the consumer is maximizing his/her utility levels. The K is special because Marginal Rate of Substitution = Price Ratio and the utility is maximum at point K.

b. The consumer is able to maximize the level of satisfaction at point K compared to the point M and K which represents a lower level of utility for the consumer