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7. (4 Points) Explain intuitively why the optimal bundle occurs where the budget line is tangent to an indifference curve. 8.
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Answer #1

Due to presence of HOMEWORKLIB POLICY, I am answering first question.

7.

Ans:

Slope of budget line = Price of Good X / Price of Good Y

= Amount of good Y required to be sacrificed to have one more unit of X.

Slope of IC = Marginal utility of X / Marginal utility of Y

= Amount of good Y willing to sacrifice to have one more unit of X.

Intuition:

If a person is willing to sacrifice more of Y than what is required to have more X then the person should have more X as sacrifice requirement is currently less and after having more of X, sacrifice willingness will reach sacrifice requirement.

If a person is willing to sacrifice less of Y than what is required to have more X then the person should have less X as sacrifice requirement is currently more and after having less of X, sacrifice willingness will reach sacrifice requirement.

Note: Here, sacrifice requirement acts as a constraint having upper limit.

Other way of understanding:

MRS(MUx / MUy = slope of IC) should equate Px / Py(Slope of Budget) as optimizing consumer needs:

MUx / Px = MUy / Py.

In other words. marginal utility per price should be equal for all goods. If not, then consumer gains in consuming more of good having larger (MU / price).

If you are satisfied with the answer, please provide a positive rating. Feel free to comment in case of queries.

Have a nice day ahead!

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