The Theory of Consumer Choice The Theory of Consumer Choice: Microeconomics
The Theory of Consumer Choice The Theory of Consumer Choice: Microeconomics
The Theory of Consumer Choice The Theory of Consumer Choice: Microeconomics
PRINCIPLES OF
N. GREGORY MANKIW
arcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
In this chapter, we will look for the answers
to these questions:
How does the budget constraint represent the choices a
consumer can afford?
How do indifference curves represent the consumer’s
preferences?
Analyze how a consumer’s optimal choices are determined
See how a consumer responds to changes in income and
changes in prices
Impact of a price change in an income effect and a substitution
effect
THE BUDGET CONSTRAINT:
WHAT THE CONSUMER CAN AFFORD
The budget constraint depicts the limit on the consumption “bundles” that a
consumer can afford.
People consume less than they desire because their spending is constrained,
or limited, by their income.
The consumer’s budget constraint shows the various consumption bundles
that the consumer can afford for a given income
The budget constraint shows the various bundles of goods that the consumer can buy for a4 given
income. Here the consumer buys bundles of pizza and Pepsi. The table and graph show what the
consumer can afford if his income is $1,000, the price of pizza is $10, and the price of Pepsi is $2.
Figure 1 The Consumer’s Budget Constraint
Quantity
of Pepsi
500 B
• If the consumer
buys no pepsi, he
can afford 100
pizzas (point A). If
C
he buys no pizza, 250
he can afford 500
pints of pepsi Consumer’s
(point B). budget constraint
A
0 50 100 Quantity
of Pizza
The slope of the preceding graph is
-5 (the price of Pepsi/the price of
Quantity
of Pepsi
C
B D
MRS I2
1
Indifference
A curve, I1 Quantity
of Pizza
0
The consumer’s preferences are represented with indifference curves, which show the combinations of pizza and Pepsi that
make the consumer equally satisfied. Because the consumer prefers more of a good, points on a higher indifference curve (I2
here) are preferred to points on a lower indifference curve (I1). The marginal rate of substitution (MRS) shows the rate at
which the consumer is willing to trade Pepsi for pizza. It measures the quantity of Pepsi the consumer must be given in
What does the Slope of Indifference Curves
represent ?
u The slope at any point on an indifference curve is the
marginal rate of substitution.
u It is the rate at which a consumer is willing to substitute
one good for another.
u 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 curves
4 7 I2
5 I1
2
I1 I2 I3
0 1 2 3 Dimes 0 5 7 Right
shoes
When two goods are easily substitutable, such as nickels and dimes, the indifference curves are
straight lines, as shown in panel (a). When two goods are strongly complementary, such as left
shoes and right shoes, the indifference curves are right angles, as shown in panel (b).
OPTIMIZATION: WHAT THE CONSUMER CHOOSES
Figure 7 An Increase in Income
Quantity
of Pepsi New budget constraint
Initial
budget
constraint I1
0 Quantity
2. . . . raising pizza consumption . . . of Pizza
Figure 8 An Inferior Good
Quantity
of Pepsi New budget constraint
Initial
budget I1 I2
constraint
0 Quantity
2. . . . pizza consumption rises, making pizza a normal good . . . of Pizza
A Change in Price
Quantity A fall in the price of any good will
of Pepsi New budget shift the budget constraint outward
D constraint and will change the slope of the
1,000 budget constraint.
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