15 terms

CH 21 Consumer Choice

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Budget Constraint
depicts the limit on the consumption "bundles" (combinations) that a consumer can afford.
-People consume less than they desire(the assumption is more is always a good thing) because their spending is constrained, or limited, by their income/budget
(income)=(price of good 1)(quantity of good 1) + (price of good 2)(quantity of good 2)
The Consumer's Budget Constraint
Any point on the budget constraint line indicates the consumer's combination or trade off between two goods.
EX: if the consumer buys no pizzas, he can afford 500 pints of Pepsi (point B). If he buys no Pepsi, he can afford 100 pizzas (point A). Alternatively, the consumer can buy any combination on or within the line
slope of the budget constraint line
equals the relative price of the two goods, that is, the price of one good compared to the price of the other.
It measures the rate at which the consumer can trade one good for the other
LAST CARD ON TEST: How would the Budget Constraint (Production possibility on the consumer side) Line changed if one price increased (decreased)? What if income increased (decreased)?
If one income increased then your budget constraint line goes outward. If one income decreased then, your budget constraint line come inward. If one price decreased, then the amount you are able to buy decreases; the budget constraint line goes in on the x-axis or the y-axis; not both. If one price increase, then the amount you are able to buy increases; the budge constraint line goes out to the right on the x-axis or the y axis but not both.
indifference curve
a curve that shows consumption bundles that give the consumer the same level of satisfaction.
marginal rate of substitution
The slope at any point on an indifference curve
It is the rate at which a consumer is willing to trade one good for another.
It is the amount of one good that a consumer requires as compensation to give up one unit of the other good.
Four Properties of Indifference Curve
Higher indifference curves are preferred to lower ones.
Indifference curves are downward sloping.
Indifference curves do not cross.
Indifference curves are bowed inward.
Property 1: Higher indifference curves are preferred to lower ones.
Consumers usually prefer more of something to less of it.
Higher indifference curves represent larger quantities of goods than do lower indifference curves.
Property 2: Indifference curves are downward sloping.
A consumer is willing to give up one good only if he or she gets more of the other good in order to remain equally happy.
If the quantity of one good is reduced, the quantity of the other good must increase.
For this reason, most indifference curves slope downward.
Property 3: Indifference curves do not cross
Points A and B should make the consumer equally happy.
Points B and C should make the consumer equally happy.
This implies that A and C would make the consumer equally happy.
But C has more of both goods compared to A.
Transitivity!!!! - if you prefer x to y and y to z then you prefer x to z
Property 4: Indifference curves are bowed inward.
People are more willing to trade away goods that they have in abundance and less willing to trade away goods of which they have little.
These differences in a consumer's marginal substitution rates cause his or her indifference curve to bow inward.
Indifference Curves and Utility
A utility function is simply a way to represent your preferences to show how you rank bundles of goods.
Think of utility as well-being
All points on an indifference curve provide the person with the same level of utility
Perfect Substitutes
Two goods with straight-line indifference curves are perfect substitutes.
The marginal rate of substitution is a fixed number.
Perfect Complements
Two goods with right-angle indifference curves are perfect complements.
Consumer's Optimal Choice
To determine: combine the indifference curve and the budget constraint
occurs at the point where the highest indifference curve and the budget constraint are tangent.