Ch08-8e

Preferences and Indifference Curves
I2 is an indifference curve above I1. Lisa prefers any point on I2 to any point on I1 . For example, Lisa prefers point J to either point C or point G.
Consumption Possibilities
Figure 8.1 shows Lisa’s budget line. Divisible goods can be bought in any quantity along the budget line (gasoline, for example). Indivisible goods must be bought in whole units at the points marked (movies, for example). Lisa can afford any point on the budget line or inside it.
Consumption Possibilities
The Budget Equation We can describe the budget line by using a budget equation. The budget equation states that Expenditure = Income Call the price of soda PS, the quantity of soda QS, the price of a movie PM, the quantity of movies QM, and income Y. Lisa’s budget equation is: PSQS + PMQM = Y.
Preferences and Indifference Curves
All the points above the indifference curve are preferred to the points on the curve. And all the points on the indifference curve are preferred to the points below the curve.
Preferences and Indifference Curves
A preference map is series of indifference curves. Call the indifference curve that we’ve just seen I1. I0 is an indifferenny point on I1 to any point on I0 .
Consumption Possibilities
PSQS + PMQM = Y Divide both sides of this equation by PS, to give: QS + (PM/PS)QM = Y/PS Then subtract (PM/PS)QM from both sides of the equation to give: QS = Y/PS – (PM/PS)QM The term Y/PS is Lisa’s real income in terms of soda. The term PM/PS is the relative price of a movie in terms of soda.
CHAPTER
8
Possibilities, Preferences, and Choices
After studying this chapter you will be able to
Describe a household’s budget line and show how it changes when prices or income change Make a map of preferences by using indifference curves and explain the principle of diminishing marginal rate of substitution Predict the effects of changes in prices and income on consumption choices Predict the effects of changes in wage rates on work-leisure choices
Relative price is the magnitude of the slope of the budget line.
The relative price shows how many sodas must be forgone to see an additional movie.
Consumption Possibilities
Consumption Possibilities
The budget line is a constraint on Lisa’s choices. Lisa can afford any point on her budget line or inside it. Lisa cannot afford any point outside her budget line.
Preferences and Indifference Curves
Marginal Rate of Substitution The marginal rate of substitution, (MRS) measures the rate at which a person is willing to give up good y, (the good measured on the y-axis) to get an additional unit of good x (the good measured on the x-axis) and at the same time remain indifferent (remain on the same indifference curve). The magnitude of the slope of the indifference curve measures the marginal rate of substitution.
Subterranean Movements
–Like the continents floating on the earth’s mantle, spending patterns change slowly over time, but as they change, business empires rise and fall. –The model of consumer choice that we study in this chapter explains such things as: –Why as the prices of a music download, iPod, and CD burner have fallen, people are buying more downloads and fewer CDs. –Why we don’t (much) buy too many electronic textbooks, even though they are cheaper than printed textbooks.
Preferences and Indifference Curves
Lisa can sort all possible combinations of goods into three groups: preferred, not preferred, and indifferent.
An indifference curve joins all those points that Lisa says are just as good as C. G is such a point. Lisa is indifferent between C and G.
Preferences and Indifference Curves
An indifference curve is a line that shows combinations of goods among which a consumer is indifferent.
Figure 8.3(a) illustrates a consumer’s indifference curve. At point C, Lisa consumes 2 movies and 6 six-packs a month.
Preferences and Indifference Curves
If the indifference curve is relatively steep, the MRS is high. In this case, the person is willing to give up a large quantity of y to get a bit more x. If the indifference curve is relatively flat, the MRS is low. In this case, the person is willing to give up a small quantity of y to get more x.
Figure 8.2(a) shows the rotation of a budget line after a change in the relative price of movies.