Budget line: The limits to a household’s consumption choices
o Consumer choices are limited by income and by prices, and households cannot
influence the price of goods and services it buys.
o Divisible goods: Goods that can be bought in any quantity desired (assumed)
o Indivisible goods: Goods that can be bought in set quantity (intermediate points)
o Affordable quantities: The area inside the budget line and the points on it are affordable
o Unaffordable quantities: The area outside the budget line is unaffordable.
o Expenditure: Sum of the price of each good multiplied by the quantity bought (assumed to be same as income)
o Given expenditure = price of (1) x quantity of (1) + price of (2) x quantity of (2)
Y = P1Q1+ P 2 2
⁄ = Q 1 ⁄ Q2
Q1= ⁄ ⁄ Q2
o Real income: A household’s income expressed as quantity of good that the household can afford to buy
Point at which the budget line intersects the y ax)s (
o Relative price: The price of one good divided by the price of the other.
Magnitude of the slope of the budget lin⁄ (
Equivalent to the opportunity cost of a good
o When the price of a good measured on the x-axis increases, the budget line rotates inward (vice versa)
o When income decreases, the budget line shifts inward (vice versa)
Indifference curve: Line that shows combinations among which a consumer is indifferent.
o Convex shaped
o Has no relation to prices or any other variables
o A consumer is just as happy to consume any point on the indifference curve.
o A consumer prefers the combinations above the indifference curve to those inside or un