Given a Typical Set of Indifference Curves and a Budget

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The Answer is The amount an investor consumes over the period is constrained by the amount of income the investor has available in the period.A budget constraint specifies the options that are available to the investor,and can be used to determine the opportunity set.The first part of the analysis is to determine the options open to the investor.One option available is to save nothing and consume everything on receipt.The second option is to save all income received on date 1.On date 2,income saved on the first date plus interest earned on it is consumed along with the income received on date 2.The third option is to consume everything now and not worry about tomorrow.The amount consumed would be the amount received on date 1 and the amount that can be borrowed against the amount to be received on date 2.This can be plotted on a graph as a straight line to depict the investor's opportunity set.
The economic theory of choice states that an investor chooses among the opportunities in the opportunity set by specifying a series of curves called utility functions or indifference curves.These curves represent the investor's preference for income over a period.The optimum consumption pattern for the investor is determined by the point at which an indifference curve is tangent to the opportunity set.The investor can select either of the two consumption patterns indicated by the points where the indifference curve intersects the opportunity set.This is because an investor is better off selecting a consumption pattern lying on a higher indifference curve.However,an investor cannot choose an indifference curve above the opportunity set as there is no feasible investment opportunity available on this curve.The investor will move to higher indifference curves until the highest one that contains a feasible consumption pattern is reached.In other words,the optimum consumption pattern is where the highest feasible indifference curve is just tangent to the opportunity set.

Given a Typical Set of Indifference Curves and a Budget

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