Chapter 21 – The Theory of Consumer
- People face trade-offs. (from Chapter One)
o Buying more than one good leaves less income to buy other goods.
o Working more hours means more income and more consumption, but less leisure time.
o Reducing saving allows more consumption today but reduces future consumption.
o Spends more income on present and saves less of it.
The Budget Constraint: What the consumer can afford
- Budget constraint – the limit on the consumption bundles that a consumer can afford
o Example: Hurley divides his income between two goods: fish and mangos
o A “consumption bundle” is a particular combination of goods, e.g., 40 fish & 300
Representing Preferences with Indifference Curves
- Consumer indifference curve – a curve that shows the various bundles of goods that make the
consumer equally happy.
o Points on higher indifference curves are preferred to points on lower indifference
o The slope of an indifference curve at any point is the consumer marginal rate of
substitution- the rate at which the consumer is willing to trade one good for another.
Four Properties of Indifference Curves
- Property 1: Higher indifference curves are preferred lower ones.
- Property 2: Indifference curves are downward sloping. - Property 3: Indifference curves do not exist.
- Property 4: Indifference curves are bowed inward. One Extreme Case: Perfect Substitutes
Another Extreme Case: Perfect Complements Less Extreme Cases: Close Substitutes and Close Complements
Optimization: What the Consumer Chooses
- The consumer optimizes by choosing the point on his budge