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Chapter 5

ECON2310 Chapter 5: Intermediate MicroEcon - Chapter 5 Notes


Department
Economics
Course Code
ECON 2310
Professor
Asha Sadanand
Chapter
5

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Chapter 5 – Constraints, Choices and Demand
02/20/2016
Learning Objectives
1. Demonstrate how price and income affect a consumers budget line
2. Determine a consumers best choice based on preferences and
budget line
3. Understand how to find a consumers best choice by maximizing a
utility function
4. Analyze the effects of changes in prices and income on a
consumer’s demand
5. Explain how economists determine consumers preferences based on
their choices
Consumer choice is all about constraints and trade-offs. The
purpose of this chapter is to describe the constraints consumers
face and explain how they resolve trade-offs and make decisions.
We’ll examine 6 topics;
1. Affordable consumption bundles: consumers budget constraints
identify all the consumption bundles they can afford. We’ll see how
prices and income determine which consumption bundles are
affordable.
2. Consumer choice: faced with a budget constraint, consumers select
the best consumption bundles they can afford. We’ll explain how to
determine the best choice given preferences and budget
constraints.
3. Utility maximization: many important economic questions are
quantitative, which is why economists use mathematics. We’ll see
that a consumers best choice corresponds to the solution to a
mathematical problem involving the maximization of utility, a
concept that we introduced in Section 4.4, subject to a budget
constraint.
4. Prices and Demand: when the price of a good changes, each
consumers best affordable consumption bundle may change with it.
By studying this relationship, we will develop a better
understanding of demand curves.
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5. Income and Demand: when a consumer’s income changes, the best
affordable consumption bundle changes. Studying this relationship
will help us understand how and why demand depends on income
6. How economists determine a consumers preferences: economists
cant observe consumers preferences directly. However, they can
observe choices. We’ll see how economists learn about consumers
preferences from their choices.
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find more resources at oneclass.com

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5.1 Affordable Consumption Bundles 02/20/2016
Income, Prices, and the Budget Line
A consumers income consists of the money he receives during some
fixed period of time.
A consumer can afford to purchase a bundle if its cost is less than
her/his income for that period
The Consumers Budget Constraint
Cost of Consumption bundle ≤ Income;
Or more formally, a bundle is affordable if its total cost does not
exceed income.
Ps S + Pb B ≤ M
When each good is available at a fixed price per unit, the budget
constraint will take the form shown in the formula above.
A bundle exhausts consumers income if its cost strictly equals
income (M)
For Finely Divisible Goods
By subtracting Ps S from both sides and then dividing everything
through by Pb, we can rewrite the formula as follows;
B= (M/Pb) – (Ps/Pb)S
This formula describes a straight line, known as the consumers
budget line. By graphing this (Figure 5.1), we can identify all of the
consumption bundles that just exhaust the consumers income
Figure 5.1 – The Budget Constraint
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find more resources at oneclass.com
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