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Economics 1021A/B Lecture Notes - Indifference Curve, Substitute Good, Divisor

Course Code
ECON 1021A/B
Emilie Rivers

of 4
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
PXQX + …(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
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 curve and budget line
On the Highest Attainable Indifference Curve
Every point on the budget line lies on an indifference curve
MRS = Relative Price
Magnitude of slope of indifference curve = magnitude of slope of budget line
Willingness to pay for a good equals opportunity cost of that good
A Change in Price
Price effect effect of a change in the price of a good on the quantity of the
good consumed
When the price of one good falls and the price of another good and income
remain constant, substitute first good for second
The Demand Curve
Demand curve is made u of points (intersection of indifference curve and
budget line) plus all the other points that are best affordable quantities of
one good at each good price with the price of the second good and income
remaining the same
Demand curve slopes downward lower price of movie (Lisa example), more
movies she sees Law of Demand
A Change in Income
Effect of a change in income on buying plans
Price remaining constant
When income falls, buy less of both goods normal goods
The Demand Curve and the income Effect
A change in income leads to a shift in the demand curve
Lower income shift left of the curve
Substitution Effect and Income Effect
Normal good fall in its price always increase the quantity bought
Substitution Effect
Effect of a change in price on the quantity bought when the consumer
remains indifferent between the original situation and the new one
Lower income enough to keep on the same indifference curve