Question

Assume Luis spends his entire income on X and Y, and his indifference curves have the usual convex shape. If Luis maximizes his utility, then:

a. there are other bundles that are preferred at the current price ratio.
b. the slope of his indifference curve is smaller than the slope of his budget line.
c. he spends his entire available income.
d. the slope of his indifference curve is greater than the slope of his budget line.

Answer 1

Answer:

c. he spends his entire available income.

Explanation:

If Luis wants to maximize his utility, he will need to spend all his money and locate himself in the point of the curve that is tangent to his personal budget line. At this point, the curve's slope is equal to the price ratio of the goods.

The marginal rate of substitution at this point is equal to the slope of the curve, i.e. how much of a product you have to give up in order to gain more utility from another product.