Corner Solution

Definition

A corner solution refers to a situation in which an individual's optimal choice is to consume only one good from a set of available goods, rather than a combination of goods. This occurs when the individual's budget constraint is tangent to one of the axes in the consumption space, indicating that the opportunity cost of consuming the other good is prohibitively high.

5 Must Know Facts For Your Next Test

1. A corner solution arises when the individual's indifference curve is tangent to one of the axes in the consumption space, indicating that the optimal choice is to consume only one good.
2. Corner solutions are more likely to occur when the relative prices of the goods are very different, making the opportunity cost of consuming the other good prohibitively high.
3. Corner solutions can also occur when the individual has a strong preference for one good over the other, causing the indifference curve to be highly skewed towards the preferred good.
4. The presence of a corner solution means that the individual will not consume a combination of the two goods, but rather will specialize in the consumption of the good with the lower relative price or the one they prefer more.
5. Corner solutions are important in understanding consumer behavior and can have significant implications for the demand for goods and the equilibrium in markets.

Review Questions

• Explain how the budget constraint and indifference curves influence the occurrence of a corner solution.
  • The budget constraint and indifference curves together determine the optimal consumption choice for an individual. When the budget constraint is tangent to one of the axes in the consumption space, it indicates that the opportunity cost of consuming the other good is prohibitively high. In this case, the individual's indifference curve will also be tangent to the same axis, resulting in a corner solution where the individual consumes only one good. The relative prices of the goods and the individual's preferences play a crucial role in determining the likelihood of a corner solution.
• Analyze the implications of a corner solution for the demand for goods and the equilibrium in markets.
  • The presence of a corner solution has significant implications for the demand for goods and the equilibrium in markets. When an individual specializes in the consumption of one good due to a corner solution, the demand for that good will be higher, potentially leading to a higher equilibrium price. Conversely, the demand for the other good will be lower, potentially leading to a lower equilibrium price. This can have ripple effects on the overall market equilibrium and the allocation of resources. Understanding corner solutions is essential for policymakers and businesses to make informed decisions about pricing, production, and resource allocation.
• Evaluate the role of opportunity cost in the formation of a corner solution, and explain how it affects the individual's decision-making process.
  • The opportunity cost is a crucial factor in the formation of a corner solution. When the relative prices of the goods are very different, the opportunity cost of consuming the other good becomes prohibitively high. In this case, the individual's indifference curve will be tangent to one of the axes, indicating that the optimal choice is to consume only the good with the lower relative price or the one they prefer more. The individual's decision-making process is heavily influenced by the opportunity cost, as they weigh the benefits of consuming each good against the cost of forgoing the other. By understanding the role of opportunity cost in the formation of a corner solution, we can better predict and explain the consumption choices made by individuals in various economic scenarios.

Related terms

Budget Constraint:

The budget constraint represents the maximum combination of goods an individual can purchase given their income and the prices of the goods.

Indifference Curve: An indifference curve represents all the combinations of goods that provide the same level of utility or satisfaction to an individual.

Opportunity Cost:

The opportunity cost is the value of the next best alternative foregone when making a choice.