Question

Perfect substitutes refer to goods with a constant substitution rate. To find the bundle (corner point) for perfect substitutes, which of the following statements is true?

a) The bundle can be found at the point where the budget line is tangent to the highest indifference curve.
b) The bundle can be found at any point along the budget line.
c) The bundle can only exist at the intercepts of the budget line on the axes.
d) The bundle cannot be determined for perfect substitutes.

Answer 1

For perfect substitutes, the utility-maximizing bundle is found at the intercept of the budget line on an axis, indicating consumers will spend their entire budget on the good which maximizes utility per dollar. Option c.

Step-by-step explanation:

When analyzing perfect substitutes and determining the utility-maximizing choice, it is essential to understand that these goods can be exchanged for one another at a constant rate.

For such goods, you can usually think of this as a straight-line indifference curve, indicating that the consumer is indifferent between bundles of the two goods as long as they are on the same line.

Therefore, the utility-maximizing bundle for perfect substitutes is found at the point where the consumer spends their entire budget on the good that provides the highest utility per dollar, which typically occurs at one of the intercepts of the budget constraint on an axis.

This means the correct statement is: c) The bundle can only exist at the intercepts of the budget line on the axes.

The utility-maximizing corner point is chosen instead of any point of tangency because perfect substitutes have indifference curves that don't have the typical convex shape to the origin.

Since the slope of the indifference curves for perfect substitutes is constant, the consumption bundle that maximizes utility does not require the budget line to be tangent to the highest possible indifference curve, unlike with other types of goods.

Option C.