ECN104 – Chapter 21 Notes
Chapter 21 Notes
o How does the budget constraint represent the choices a consumer can
o How do indifference curves represent the consumer’s preferences?
o What determines how a consumer divides her resources between two
o How does the theory of consumer choice explain decisions such as how
much a consumer saves, or how much labour she supplies?
o Recall one of the Ten Principles from Chapter 1: People face
Buying more of one good leaves less income to buy other goods
Working more hours means more income and more consumption,
but less leisure time
Reducing saving allows more consumption today but reduces
o This chapter explores how consumers make choices like these.
• The Budget Constraint: What the Consumer Can Afford
o E.g., Hurley divides his income between two goods: fish and mangos.
o A “consumption bundle” is a particular combination of the goods, e.g.,
40 fish and 300 mangos
o Budget constraint: the limit on the consumption bundles that a
consumer can afford
• The Slope of Budget Constraint
o “rise” = -200 mangos
o “run” = +50 fish
o Slope = -4
Hurley must give up 4 mangos to get one fish
o The slope of the budget constraint equals
The rate at which Hurley can trade mangos for fish
The opportunity cost of fish in terms of mangos
The relative price of fish:
• Price of fish / price of mangos • The Income and Substitution Effects
o A fall in the price of fish has two effects on Hurley’s optimal consumption
of both goods.
Income Effect: A fall in Pf boosts the purchasing power of
Hurley’s income, allows him to buy more mangos and more fish.
Substitution Effect: A fall in Pf makes mangos more expensive