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Economic Theory

combination of OX1 amount of Good X and OY1 amount of Good Y. Any
other possible combination of the two goods will either yield lesser
satisfaction or will not be unobtainable at present prices, with the given
amount of income of the consumer.

At the point of equilibrium (point C) the price-line LM is tangential to
the indifference curve I3. At point C, the indifference curve and the price-

line have the same slope. Now the slope of the indifference curve
represents the marginal rate of substitution; and the budget line shows the
ratio of prices between the two goods. At point C the marginal rate of
substitution between the two goods as indicated by the slope of the

indifference curve I3 and the ratio of prices between the two goods as
indicated by the price-line LM are equal. This point, therefore, indicates
the ideal combination between the two commodities, giving the consumer

the highest satisfaction possible with his limited income. At this point,
therefore the consumer is in equilibrium.

ASSIGNMENTS

Review Questions

1. Explain the characteristics of human wants.

2. Define total utility and marginal utility. What is the relationship
between total utility and marginal utility?
3. Would you expect total utility to rise or fall with additional

consumption of a good? Why?
4. Define the law of diminishing marginal utility and give an example
of it in practice.

5. Give an algebraic restatement of the utility-maximizing rule that is
based on an example using two products, A and B.
6. Define the law of equi-marginal utility.

7. What is indifference curve? What are the properties of indifference
curve?
8. What is indifference map?
9. What is budget line? Illustrate the budget line with a graph.

10. How does a change in the price of one product shift the budget
line? Explain and illustrate with a graph.

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