How we reach to the Optimal Choice of the Consumer?
What is Indifference Curve? | What is Indifference Map? | What is Budget Set? | What is Budget Line? | Introduction
In previous sessions, we saw how consumer gains utility or
satisfaction from different bundles or combinations of goods. There are set of
bundles or combination among which the consumer is indifferent to receive and
consume. And when that combination is plotted on a graphical representation, those
points are joined to become a curve which we call as Indifference curve. The
indifference curves show all the bundles or combination of goods between which
the consumer is indifferent to consume. Why the consumer is indifferent? Because
all of those bundles on the indifference curve gives same or equal level of
utility or satisfaction to the consumer.
We also saw that when the preferences are monotonic, where there
are bundles of goods on an indifference curve and one new bundle is formed with
quantity of one of the good in the bundle is increased with remaining goods
quantity being no less than other bundles of indifference curve, the new bundle
would now get placed on a higher indifference curve. Because increased quantity
of any of the good with other goods at least constant or more, will always give
more utility to the consumer and hence will always be preferred by the
consumer.
And as the means to consume the bundles increases, the
available bundles to the consumer then form a higher indifference curve that
will be above the previous one. And all these curves when plotted on a graph what
we get is called an Indifference Map.
The income with the consumer is limited and consumers either
spend all of their income or may be less. Now accordingly, there will be
different bundles of goods available to the consume that the consumer can buy
which either would be costing less or equal to their total income. When we
consider all those options or set of available bundles that the consumer can
afford and is willing to buy, that set of bundles or combinations is known as
Budget Set.
When total costs of the goods demanded by the consumer
equals the income of the consumer, we get a line in a graphical representation,
known as Budget Line. So budget line is made up of all the bundles which costs
total income to the consumer.
Now consumer needs to choose the bundle or combination of
goods from the budget set, best suited for them, which we call it as the
Optimal Choice of the Consumer.
Optimal Choice of the Consumer
The consumers have their own taste and preferences on the
basis of which they decide which bundle to choose from the several available
under their budget set. In economics we assume that consumer has well decided
taste and preferences and they can compare two different bundles and can decide
which to choose. So they finally either prefer any of the bundle or can remain
indifferent between a set of bundles.
Other important assumption in economics, is that the
consumers are rational individuals. They can very well differentiate between
what is good or bad for them and as a rational individual they always try to
achieve which is best for them. So consumers have their own taste and
preferences and as a rational individual they can also function accordingly to
choose the bundles of goods which gave them maximum utility or level of satisfaction.
We know that, all the available bundles or combination of
goods that the consumer can consume are presented in the Budget Set. And in the
budget set, the consumer’s preferences are marked with the help of set of
indifference curves which is known as Indifference Map.
Consumer’s problem
As we know, in economics we always try to solve a problem be
it at micro level or aggregate level. And the concepts and theories in economics
helps solving the same. To solve a problem, first it is very important to
define the same. So here what is the problem?
In simple terms, the problem is what should be the optimal
choice of the consumer from the available set of bundles and combinations to
choose from the Budget Set? In technical terms, the problem of the consumer is
to reach a point representing optimal bundle on the highest indifference curve
possible from the budget set formed considering price and income constraint.
How to reach that point of Optimal Choice?
Obviously such a point would surely be on the graphical
representation showing the budget set and budget line considering it as a
universal set here for the time being for the consumer. The graphical
representation is structured with a Budget Line and set of Indifference Curves
over a Budget Set.
The point of optimal choice would be on the Budget Line.
Because any bundle in the budget set which is below the budget line, would be
having either of any one less with other good being same or less. Or in other
words, any point representing a bundle of good on the budget line as compared
to a bundle below it, would be having at least one of the good more with other
being no less. Thus as per the phenomenon of Monotonic Preferences, consumer
will always prefer a bundle with more of at least one of the good as compared
to other bundle, with rest of goods being of equal quantity.
So now we know that the point of optimal choice would be on
the Budget Line, but still we are half way. Where that point of optimal choice
showing optimal bundle would be located on the budget line?
The optimal choice of bundle would be located at the point on the budget line which is tangent to one of the indifference curves.
But Why?
Because that is the point at which the absolute value of Marginal
Rate of Substitution which features the slope of the indifference curve and Price
Ratio of goods which features the slope of the budget line are equal. The slope
of the indifference curve or Marginal Rate of Substitution is the rate at which
consumer is willing to substitute a particular good for the other. The slope of
the budget line or the price ratio of goods is the rate at which the consumer
is able to substitute a particular good for the other. Hence the point at which
both rates become equal shows the willingness as well as ability of the
consumer to consume that particular optimal bundle which is the core of the
concept of demand. Thus the point of tangent between the budget line and the
indifference curve or the point at which the two rates are equal is the optimal
point of choice or point denoting the optimal bundle.
Another way to look at it is that, any point on the budget line other than the one which is tangent to the indifference curve, lies on a lower indifference curve confirming out rightly it as inferior. Thus any point on a lower indifference curve could not be the optimum choice of the consumer when the consumer has preferences as well as ability for consuming an optimal bundle giving higher level of utility or satisfaction.
In the above graphical representation, we can see that point
of tangent of the budget line with the indifference curve - 2, is the point of optimum
bundle for the consumer. Any other point on the budget line, lies on a lower
indifference curve – 1, confirming its inferiority. It is also important to
note that the indifference curve – 2 which is tangent to the budget line is the
highest possible indifference curve for the given budget set for the consumer.
And the bundles on the indifference curve – 3 which is above the budget line
are clearly not affordable to the consumer due to income constraint. Thus q1
shows quantity of Apples and q2 shows quantity of bananas and (q1, q2) is the
optimal choice of bundle from which the consumer will receive optimum
satisfaction.
Conclusion
In this session, we discussed in detail on how the consumers decides the optimal choice of bundle or combination of goods from which they receive the optimum satisfaction or utility, with the help of budget set, budget line and indifference curve.
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