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Indifference curves, the budget line and consumer equilibrium sheet
Essay frame

Explain consumer equilibrium using indifference curve analysis.

How to lay out the answer. Follow the frame, then write it in your own words.

  1. 1 · Introduce the ordinal approach. Hicks and Allen: consumers rank bundles; no need to measure utility.
  2. 2 · Define IC, indifference map and MRS. Use a short schedule showing MRS falling: 5, 4, 3, 2.
  3. 3 · State the properties.
    • Downward sloping
    • Convex to origin
    • Never intersect
    • Higher IC = higher satisfaction
  4. 4 · Derive the budget line. Px·X + Py·Y = M; intercepts M/Px and M/Py; slope −Px/Py. Example: 20 X or 40 Y, slope −2.
  5. 5 · Draw the equilibrium. [Diagram: indifference map with IC1, IC2, IC3 and a budget line tangent to IC2 at E; points on IC1 crossing the line marked as inferior choices]
  6. 6 · State the conditions. MRSxy = Px/Py at E, and the IC is convex. If MRS > Px/Py buy more X; if less, buy less X.
  7. 7 · Sri Lankan business link. Telecom bundles and price cuts pivot customers' budget lines to win a larger share of spending.
  8. 8 · Conclude. The consumer is best off at the tangency point: the highest satisfaction the budget allows.

Scoring tip: The equilibrium diagram is the answer. Draw at least three ICs and label E clearly.