Let us consider the core problem; choosing a commodity bundle which maximizes an individual’s satisfaction among all the bundles that he can afford. Sometimes the problem is also referred to as the consumer’s optimization problem. The answer is straightforward. We know the concept and implications of budget line and indifference curve.
Consumer’s equilibrium can be defined as a point where the budget line of a consumer is tangent to his indifference curve. The commodity bundle characterizing the consumer’s equilibrium is the one that the consumer will choose, because choosing any other bundle is either unaffordable to him or will leave him worse off in terms of satisfaction.
Let us explore this in detail. The consumer would like to attain the highest possible indifference curve in order to derive the maximum possible level of satisfaction. On the other hand, he is constrained by his budget.
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Clearly, to achieve maximum satisfaction within his budget, the consumer would logically try to attain that indifference curve which is tangent to the budget line. The point of tangency is known as the consumer’s equilibrium point.
Any point on the right side of the point of tangency is beyond his financial capacity. On the contrary, any point that lies on the left side of the point of tangency shows that his budget is not totally exhausted and he can still spend some amount of money in order to enhance his satisfaction level. So, the other points, excepting the point of tangency, reflect the fact that either the bundle is not affordable or that it is less preferred.
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Consider diagram 7.13 where the vertical axis measures number of apples and the horizontal axis measures number of oranges.
The equilibrium of the consumer is given by the commodity bundle A on the indifference curve IC2 where 6 oranges and 4 apples are consumed by the consumer. Of course, the consumer would like to attain a higher indifference curve like IC3 (here IC3 represents indifference curve that lies above IC2) but he cannot afford to do so with his budgetary allocation. At point A, where the indifference curve is tangent to the budget line, the slope of the budget line must be equal to the indifference curve.
