Economics – Indifference curves and budget lines | e-Consult

An indifference curve shaped like a straight line indicates that the consumer is perfectly content with any combination of the two goods, as they provide equal levels of satisfaction. This means the Marginal Rate of Substitution (MRS) is constant and equal to the ratio of the prices of the two goods (MRS = P_X/P_Y).

Diagram: (A diagram should be included here showing a straight-line indifference curve and a budget line that is parallel to the indifference curve. The axes should be labelled 'Good X' and 'Good Y'. The budget line should be parallel to the indifference curve.)

The consumer’s choices are determined by maximizing utility subject to the budget constraint. The consumer will choose the combination of goods on the budget line that is tangent to the highest possible indifference curve. This occurs where the MRS equals the ratio of the prices (MRS = P_X/P_Y).

If the price of one good falls, say good X, the budget line will rotate outwards, becoming steeper. The optimal consumption bundle will move along the new budget line to a point where it is still tangent to the highest possible indifference curve. Since the price of good X has fallen, the consumer can now afford more of good X and less of good Y, leading to a change in the optimal consumption bundle.