Consumer's Indifference Curve, Marginal Rate of Substitution, Consumer's Budget Constraints, Diminishing Marginal Utility, Income and Substitution Effects

Running head: ECONOMICS
Economics
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ECONOMICS
1. a) Consumer's Indifference Curve
Consumer’s indifference curve represents the graph that shows the combination of two
products which give the consumer equal level of utility and satisfaction and hence, make the
consumer indifferent between the two products. Thus, along the curve, consumers have no
preference for any combination of the products as both the products provide the equal level of
utility to the consumers (Gordon and Vaughan 2017). The indifference curve is convex to the
origin and none of the indifference curves intersects. When the consumers achieve more utility
from a bundle of goods, they move up to a higher indifference curve (Choi 2016). For example,
if a consumer’s income increases, he would move up to a higher indifference curve as he could
consume more of each of the goods.
Figure 1: Consumer’s indifference curve
Unattainable bundle of
goods

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ECONOMICS
The line PT in the above diagram shows the budget line of the consumer. C on the indifference
curve IC2 represents the equilibrium for the consumer as the combination of goods at point C
gives equal and maximum utility to the consumer. R and S are located on a lower indifference
curve, IC1 and the budget line intersects the indifference curve, thus, these 2 points provide lower
utility than C. On the other hand, point U is located on IC3 and that is out of budget line.
b) Marginal rate of substitution
Marginal rate of substitution (MRS) is referred to as the rate at which the consumer is
willing to give up or exchange one good for another good at the same level of utility (Becker
2018). MRS is represented by the slope of indifference curve. MRS is calculated between two
products that are placed on an indifference curve, which display a frontier of equal utility for
each of the combination of good 1 and good 2. It is a downward sloping curve that presents the
slope of the indifference curve for any given point that represents the combination of good 1 and
good 2.

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ECONOMICS
Good 1
Good 2
IC
8
10
14 A
B
C
20 30 45
Figure 2: Marginal rate of substitution
It can be seen from the above graph that at point A, for 20 units of good 2, the consumer will be
willing to give up 14 units of good 1. Similarly, at point B, for 10 units of good 1, the consumer
will be willing to give up 30 units of good 2. The MRS is higher for good 2 than for good 1, as
the consumer is willing to give up more of good 2 than for good 1 at the same utility level.
c) Consumer's budget constraints
Budget line graphically represents the combination of two different goods that is
affordable to the consumer within his income at the given prices. Thus, consumer’s budget
constraints refer to the combinations of goods and services, which a consumer can afford at the
given current prices (Daskalakis, Devanur and Weinberg 2018). In other words, budget
constraints can be defined as the purchasable combination of goods at their current prices that is
affordable to the consumer within his or her income.