Scribd Logo
Upload

Welcome to Scribd!

  • 77 views

    Notes On The Optimal Consumption Bundle (OCB)

    Uploaded by

    Egeruoh Chigoziri Cyrinus
    The document discusses the concept of the optimal consumption bundle (OCB). [1] The OCB is the bundle of goods that is both affordable given a consumer's budget and maximizes their utility based on their preferences. [2] At the OCB, the indifference curve showing the consumer's preferences will be tangent to their budget constraint. [3] This means the marginal rate of substitution between the goods at the OCB will equal the slope of the budget constraint, indicating the consumer cannot increase their utility further while staying within their budget.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd

    Notes On The Optimal Consumption Bundle (OCB)

    Uploaded by

    Egeruoh Chigoziri Cyrinus
    77 views3 pages
    The document discusses the concept of the optimal consumption bundle (OCB). [1] The OCB is the bundle of goods that is both affordable given a consumer's budget and maximizes their utility based on their preferences. [2] At the OCB, the indifference curve showing the consumer's preferences will be tangent to their budget constraint. [3] This means the marginal rate of substitution between the goods at the OCB will equal the slope of the budget constraint, indicating the consumer cannot increase their utility further while staying within their budget.

    Original Title

    notes_OCB

    Copyright

    © Attribution Non-Commercial (BY-NC)

    Available Formats

    PDF, TXT or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    The document discusses the concept of the optimal consumption bundle (OCB). [1] The OCB is the bundle of goods that is both affordable given a consumer's budget and maximizes their utility based on their preferences. [2] At the OCB, the indifference curve showing the consumer's preferences will be tangent to their budget constraint. [3] This means the marginal rate of substitution between the goods at the OCB will equal the slope of the budget constraint, indicating the consumer cannot increase their utility further while staying within their budget.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    77 views3 pages

    Notes On The Optimal Consumption Bundle (OCB)

    Uploaded by

    Egeruoh Chigoziri Cyrinus
    The document discusses the concept of the optimal consumption bundle (OCB). [1] The OCB is the bundle of goods that is both affordable given a consumer's budget and maximizes their utility based on their preferences. [2] At the OCB, the indifference curve showing the consumer's preferences will be tangent to their budget constraint. [3] This means the marginal rate of substitution between the goods at the OCB will equal the slope of the budget constraint, indicating the consumer cannot increase their utility further while staying within their budget.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 3

    Notes on the Optimal Consumption Bundle (OCB)

    The following notes review some material we covered in lecture on Wednesday,


    September 17th, and some material that will be discussed in lecture on Friday, September
    19th. This handout deals with the optimal consumption bundle (OCB).

    This handout may prove helpful when doing Homework 1.

    I. Tangency

    A brief review of tangency.

    Def: A line is tangent to a curve at a point (an (x,y) pair) if the line only touches the
    curve at this specific point (the slope of the line is equal to the slope of the curve at this
    point).

    Ex:

    Curve 1

    Curve 2

    Point A

    Line
    x

    In this example, Curve 1 is not tangent to the Line.

    In this example, Curve 2 is tangent to the Line at Point A.

    1
    II. Optimal Consumption Bundle and Tangency

    We’ve talked about the idea of affordability (use the budget constraint) and the idea of
    what a consumer wants, based on preferences (use indifference curves).

    We combine these two ideas to determine what the consumer would choose.

    Def: The optimal consumption bundle is the bundle of goods that is both affordable
    (contained in the budget constraint) and the most preferred by the consumer (highest
    indifference curve).

    (The OCB is the bundle that maximizes utility given the budget constraint.)

    This optimal consumption bundle is the bundle of goods the consumer will choose.

    At the optimal consumption bundle the indifference curve is tangent to the budget
    constraint. Otherwise, either the bundle is not affordable or the consumer could do
    better (get a more preferred bundle). This can be seen in the example below.

    This means, at the optimal consumption bundle, the MRS of good y for good x is equal to
    Px
    (the absolute value of the slope of the budget constraint).
    Py

    Example:

    • Two goods, x and y


    • Prices Px and Py
    • Money M
    • Standard preferences (follows from the Four Rules given in class)

    2
    Good y

    M/Py

    Point Point E
    A

    IC3
    Point C
    IC2
    Point D

    Point B IC1

    Good x
    M/Px
    First, notice that Point D and Point E are not affordable. They are outside the budget
    constraint, and thus cannot possibly be the optimal consumption bundle.

    Points A, B and C are all affordable (either on the budget constraint or below it).

    Now we need to consider which of these bundles is most preferred.

    By Rule 1 of indifference curves, higher indifference curves are preferred to lower


    indifference curves. Thus, Point C must be preferred to Points A and B.

    In this example, Point C is the optimal consumption bundle. It is the most preferred of all
    affordable bundles.

    NOTE that the optimal consumption bundle is the one bundle such that the indifference
    curve is tangent to the budget constraint.

    If you are at a bundle such that the indifference curve is NOT tangent to the budget
    constraint, either the bundle is not affordable (like Points D and E) or the bundle is not
    the most preferred (like Points A and B).

    You might also like