Class Notes (834,885)
Canada (508,790)
Economics (994)
ECON 101 (318)
Lecture

Chapter 9- Possibilities, Preferences, and Choices

6 Pages
198 Views
Unlock Document

Department
Economics
Course
ECON 101
Professor
Emanuel Carvalho
Semester
Winter

Description
Chapter 9: Possibilities, Preferences, and Choices Consumption Possibilities  Consumption choices are limited by income and by prices  A household’s budget line describes the limits to its consumption choices Divisible and Indivisible Goods  Divisible goods- can be bought in any quantity desired (e.g. gasoline & electricity)  Divisible goods also have intermediate points that form on the budget line Affordable and unaffordable Quantities  A budget line is a constraint on one’s choices  Marks the boundary between what is affordable and what is unaffordable o Can afford any point on the line and inside it  The constraint on her consumption depends on the prices and her income, and the constraint changes when the price of a good or her income changes Budget Equation  Expenditure = Income  Expenditure is equal to the sum of the price of each good multiplied by the quantity bought  E.g. Expenditure = (Price of pop X Quantity of pop) + (Price of a movie X Quantity of movie) o PPQ P P M =MY  Example:  $4Q + $8Q = $40 P M o Person can choose quantities which satisfy the equation o Q P (PM/ P P X QM= Y/ PPDivide both sides of the equation by PP o Q = Y/ P - P / P X Q P P M P M  According to the quantities desired, sub into the equation o Q P $40/$4- $8/$4X Q M =10 - 2 QMInterpret equation from budget line (slope) Real Income  A household’s real income is its income expressed as a quantity of goods that the household can afford to buy  Equal to money divided by the price of the good Relative Price  Relative price is the price of one good divided by the price of another good  P / P M P  E.g $8/$2 o Two cases of pop per movie o Or to see one movie, person must give up two cases of pop  Opportunity cost of seeing a movie  The relative price of a movie in terms of pop is the magnitude of the slope of the budget line  Recall formula: Slop equals the change in the variable measured on the x-axis as we move along the line  Magnitude of slope = relative price also the opportunity cost of movie A Change in Prices  The lower the price of the good measured on the x-axis, other things remaining the same, the flatter is the budget line  The higher the price of the good measured on the x-axis, other things remaining the same, the steeper is the budget line A Change in Income  A change in money income changes real income but does not change the relative price  The budget line shifts but the slope does not change  Increase in money income shifts the budget line rightward and vice versa Preferences and Indifference Curves  A preference map is based on the intuitively appealing idea that people can sort all the possible combinations of goods into three groups: preferred, not preferred, and indifferent  Indifference curve: a line that shows combinations of goods among which a consumer is indifferent  Person is just as happy on any point of the curve  Prefers all the combinations above the indifference curve  Does not prefer the combinations below the indifference curve  If higher, called higher indifference curve  A preference map is a series of indifference curves that resemble the contour lines on a map  By looking at the shape of the contour lines, we can draw conclusions Marginal Rate of Substitution  Marginal rate of substitution (MRS): is the rate at which a person will 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)while remaining indifferent (remaining on the same indifference curve)  The magnitude of the slope of an indifference curve measures the marginal rate of substitution  If the indifference curve is steep, the marginal rate of substitution is high. The person is willing to give up a large quantity of good y to get an additional unit of good x while remaining indifferent  If the indifference curve is flat, the marginal rate of substitution is low. The person is willing to give up a small amount of good y to get an additional unit of good x while remaining indifferent  To measure the magnitude, place a straight line against, or tangent to, the indifferent curve at point G See pg.208  As one consumers more of A and less of B, a person’s marginal rate of substitution diminishes  Diminishing marginal rate of substitution is the key assumption about preferences  Diminishing marginal rate of substitution: a general tendency for a person to be willing to give up less of good y to get one more unit of good x, while at the same time remaining indifferent as the quantity of x increases Your Own Diminishing Marginal Rate of Substitution  General rule: The greater of good A you consume, the smaller the quantity of good B you are willing to give up to consumer one additional A  The shape of a person’s indifference curves incorporates the principle of the diminishing marginal rates of substitution because the curves are bowed towards the origin  The tightness of the bend of an indifference curve tells us how willing a person is to substitute one good
More Less

Related notes for ECON 101

Log In


OR

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


OR

By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.


Submit