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Principles of Economics- Mankiw (5th) 458

Principles of Economics- Mankiw (5th) 458 - 472 PA R T S E...

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472 PART SEVEN ADVANCED TOPIC it lies above his budget constraint. The consumer can afford point B, but that point is on a lower indifference curve and, therefore, provides the consumer less satis- faction. The optimum represents the best combination of consumption of Pepsi and pizza available to the consumer. Notice that, at the optimum, the slope of the indifference curve equals the slope of the budget constraint. We say that the indifference curve is tangent to the budget constraint. The slope of the indifference curve is the marginal rate of sub- stitution between Pepsi and pizza, and the slope of the budget constraint is the relative price of Pepsi and pizza. Thus, the consumer chooses consumption of the two goods so that the marginal rate of substitution equals the relative price. In Chapter 7 we saw how market prices reflect the marginal value that con- sumers place on goods. This analysis of consumer choice shows the same result in another way. In making his consumption choices, the consumer takes as given the
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