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Chapter 9 Notes.docx

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Western University
Economics 1021A/B
Emilie Rivers

October 15 2012 Chapter 9, p204-213 Consumption Possibilities  Limited by income and prices  Budget line – limits to consumer choices Divisible and Indivisible Goods  Divisible – bought in any quantity desired (gas, electricity)  Any point on the budget line Affordable and Unaffordable Quantities  Budget line marks what is affordable and not affordable  Afford anything on budget line and below it  Cannot afford anything outside of the line Budget Equation  Expenditure ([Price x Quantity] of each good) = Income  PX X+ …(other goods)…. = Y Real Income  Income expressed as a quantity of goods that the household can afford to buy  Money income / price of the good Relative Price  Price of one good divided by the price of another good  Slope = change in the variable measured on the y-axis / change in the variable measured on the x-axis A Change in Prices  Lower the price of the good on x-axis, flatter is the budget line o Afford more  Higher price on x-axis, steeper the line o Afford less A Change in Income  A change in money income changes real income but does not change the relative price  Budget line shifts  No change in slope  Increases in money, increase real income, shift budget line right  Decrease in money income, decrease real income, shift left Preferences and Indifference Curves  Indifference curve – line that shows combinations of goods among which a consumer is indifferent  Prefer anything above indifference curve  Not preferred below the curve  Preference map – series of indifference curves Marginal Rate of Substitution  Rate at which a person will give up good y (y-axis) to get an additional unit of good x (x-axis)  Magnitude of the slope of an indifference curve – MRS  Steep curve – MRS is high, give up a large quantity of y to get an additional unit of good x  Flat curve – MRS is low, give up a small amount of y to get an additional unit of good x  Diminishing MRS – tendency for a person to be willing to give up less of good y to get one more unit of good x Degree of Substitutability  Some number will compensate for another good Close Substitutes  Goods where it doesn’t matter where they were purchased  Perfect substitutes – indifference curves are straight lines that slope downward Complements  Goods that do not substitute for each other at all  Left and Right running shoes  L shaped  The closer the two goods are to perfect substitutes, the closer the MRS is to being straight then curved Predicting Consumer Choices Best Affordable Choice  Spends all income and is on highest attainable indifference curve  Find a “best affordable point” On the Budget Line  Best affordable point is on the budget line  Intersection of indifference cur
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