ECON 110 Lecture Notes - Lecture 10: Indifference Curve, Budget Constraint
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Budget constraint: the limit on the consumption bundles that a consumer can afford. Indifference curve: shows which consumption bundles give consumer the same level of satisfaction: they are downward sloping, higher indifference curves (further from origin) are preferred to lower ones. Marginal rate of substitution (mrs): the rate at which a consumer is willing to trade one good for another. Mrs falls as you move down along an indifference curve. Perfect substitutes: two goods with straight-line indifference curves (constant mrs). Perfect complements: two goods with right angle indifference curves. Indifference curves for close substitutes are not very bowed, and indifference curve for close complements are very bowed. Optimization: point on the budget constraint that touches the highest possible indifference curve, at the optimum, the slope of the indifference curve equals the slope of the budget constraint, lhs = mrs, rhs = price ratio. Effect of a change in income: shifts budget constraint outwards, can consume on a higher indifference curve.