How do you find the optimal bundle for perfect substitutes?

With perfect substitutes, the optimal bundle is generally either at one corner of the budget constraint or the other. If you stop and think about it for a moment, the intuition behind this observation becomes clear.

How do you find perfect substitutes?

In some cases of consumption, a two-good (X and Y) consumer may prefer to substitute one of the goods, say, X, for the other good Y at a constant rate, to keep his level of utility constant, i.e., MRSX,Y = constant.

What is the equation of budget line?

Therefore, the numerical slope of the budget line is px / py which is equal to the ratio of the prices of X and Y. Since the numerical slope of the line represents the price ratio, or, the relative price of good X in terms of good Y, this line is also called the price line.

How do you find optimal bundles?

Use this equation and the equation for BL2 to find the optimal bundle: Y = 25 – (1/4)(4Y) or Y = 12.5. When Y = 12.5 then x = 50. The individual’s level of utility from consuming this consumption bundle is U = XY = (50)(12.5) = 625 units of utility.

What are the examples of perfect substitutes?

For example, a one-dollar bill is a perfect substitute for another dollar bill. And butter from two different producers are also considered perfect substitutes; the producer may be different, but their purpose and usage are the same.

What is Mrs for perfect substitutes?

For perfect substitutes, the MRS will remain constant. Lastly, the third graph represents complementary goods. In this case the horizontal fragment of each indifference curve has a MRS = 0 and the vertical fractions a MRS = ∞.

What is the formula of budget line?

What does the slope of budget line indicate?

The meaning of the budget line’s slope or price ratio is the same as the slope of a PPF. This means the slope of the curve is the relative price of the good on the x-axis in terms of the good on the y-axis.

How do you know if two goods are perfect substitutes?

If two goods are perfect substitutes, their prices (per comparable unit) must be the same if both are to be used: the elasticity of substitution between them is infinite, and any price difference will lead to all consumers choosing the cheaper. An indifference curve between them is a straight line.

What is budget line give an example?

Budget line definition The budget line is a graphical delineation of all possible combinations of the two commodities that can be bought with provided income and cost so that the price of each of these combinations is equivalent to the monetary earnings of the customer.

How does the perfect substitute goods income effect work?

Perfect Substitute Goods Income Effect If the budget increases, the consumer will have a budget line farther away from the origin. For example, if the consumer increases its income and it’s budget increases to $100, ceteris paribus, she will keep spending all her budget in good X, but her utility level will increase to 100.

Which is the optimal choice on the budget line?

1. The consumer’s optimal choice is on the budget line itself, not inside the budget constraint. This is why we can focus on the line rather than the whole set of affordable bundles. 2. At the optimal choice, the indifference curve just touches the budget line and so at this one point they have exactly the same slope.

Which is an example of a perfect substitution?

Budget constraint line is such that the slope is greater than the MRS (marginal rate of substitution) (MRS x1, x2) good 2 for good 1 at the intercept (M/p2). For example: Perfect substitutes: the solution –> spend your entire budget on the cheaper of any two goods to maximize utility.

Is the budget constraint line greater than the Mrs?

Here are some factors to keep in mind. 1. Indifference curves must interest one of the axis (not necessity or essential good) 2. Budget constraint line is such that the slope is greater than the MRS (marginal rate of substitution) (MRS x1, x2) good 2 for good 1 at the intercept (M/p2).