5.18 : Consumer Choice III

The optimal bundle that gives maximum satisfaction to a consumer lies at the point where the budget line touches the highest possible indifference curve. At this point, the slope of the budget line, representing the price ratio of the two goods, books and snacks, in our example, is equal to the slope of the indifference curve, which represents the marginal rate of substitution of the two goods.

The price ratio of the two goods is the ratio of the per unit price of books to the per unit price of snacks, which is 4:1. It shows how many units of snacks he must give up in order to afford one more unit of a book, or vice versa.

The marginal rate of substitution (MRS) shows the consumer's willingness to trade one good for another while maintaining the same level of satisfaction. It indicates how many units of snacks the student is willing to give up to gain an additional unit of a book while remaining equally satisfied. At the point of tangency, MRS equals 4:1.