Given preferences and budget constraints, we can now determine how individual consumers choose how much of each good to buy. We assume that consumers make this choice in a rational way—that they choose goods to maximize the sat- isfaction they can achieve, given the limited budget available to them. The maximizing market basket must satisfy two conditions:
- It must be located on the budget line.To see why, note that any market basket to the left of and below the budget line leaves some income unallo- cated—income which, if spent, could increase the consumer ’s satisfaction. Of course, consumers can—and often do—save some of their incomes for future consumption. In that case, the choice is not just between food and clothing, but between consuming food or clothing now and consuming food or clothing in the future. At this point, however, we will keep things simple by assuming that all income is spent now. Note also that any market basket to the right of and above the budget line cannot be purchased with available income. Thus, the only rational and feasible choice is a basket on the budget line.
- It must give the consumer the most preferred combination of goods and services.
These two conditions reduce the problem of maximizing consumer satisfaction to one of picking an appropriate point on the budget line.
In our food and clothing example, as with any two goods, we can graphically illustrate the solution to the consumer ’s choice problem. Figure 3.13 shows how
Source: Pindyck Robert, Rubinfeld Daniel (2012), Microeconomics, Pearson, 8th edition.