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Explain the equality of the MRS and the price ratio.

Asked by Topperlearning User 25th April 2016, 11:03 AM
Answered by Expert
Answer:

The optimum bundle of the consumer is located at the point where the budget line is tangent to an indifference curve. When the budget lines is tangent to an indifference curve at a point, the absolute value of the slope of the indifference curve and of the budget line are equal at that point i.e. Marginal rate of Substitution (MRS) is equal to the price ratio. The slope of the budget line is the rate at which the consumer is able to substitute one good for the other in the market. At the optimum, the two rates should be the same. Thus, a point at which the MRS is greater, the price ratio cannot be the optimum as well as when the MRS is less than the price ratio cannot be the optimum.

Answered by Expert 25th April 2016, 1:03 PM
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