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Chapter 9 Notes.docx

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Economics 1021A/B
Jeannie Gillmore

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Chapter 9 Notes Consumption Possibilities  consumption choices are limited by income and prices  a household’s budget line describes the limits to its consumption choices Divisible Goods  divisible goods are those that can be bought in any quantity desired (e/x gasoline and electricity) o when goods are considered divisible, the consumption possibilities become every single point along the budget line Affordable and Unaffordable Quantities  a budget line is a constraint on choices o marks the boundary between what is affordable and what is unaffordable  people can afford to buy any point on the line and inside of it o the constraint on consumption depends on prices and income, and the constraint changes when the price of a good or income changes o the budget equation shows the effects Budget Equation  expenditure is equal to the sum of the price of each good multiplied by the quantity bought  let income equal Y  the budget equation contains two variables chosen by the household (Q and Q ) and a b two variables that the household takes as given (Y/Paand P bP a  real income o a households real income is its income expressed as a quantity of good that the household can afford to buy  e/x Y/P a o this quantity is the maximum quantity of a good that one can buy  equal to the income divided by the goods price o this point is also the y-intercept  relative price o a relative price is the price of one good divided by the price of another good  e/x Pb/Pa o the relative price is the amount of one good you must give up to get the other (amount of a that must be given up to get 1 b) o also the opportunity cost o the relative price is the magnitude of the slope of a budget line Change in Prices  when prices change, so does the budget line o the lower the price of the good measured on the x-axis (all other things remaining the same) the flatter is the budget line  relative price decreases o the higher the price of a good measured on the x-axis (all other things remaining the same) the steeper the budget line  relative price increases Change in Income  a change in money income changes real income but does NOT change relative price o the budget line shifts, but its slope does not  an increase in money income increases real income and shifts the budget line rightward  a decrease in money income decreases real income and shifts the budget line leftward Preferences and Indifference Curves  a preference map is based on the idea that people can sort all the possible combinations of goods into three categories: o preferred, not preferred, and indifferent  an indifference curve is a line that shows combinations of goods among which a consumer is indifferent  on the above preference map: o points on
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