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CHAPTER 9: Possibilities, Preferences and Choices
• Household consumption choices are constrained by its income and the prices of the goods
and services available.
• The budget line describes the limits to the household’s consumption choices
o The budget line is a constraint on Lisa’s consumption choices.
o Lisa can afford any point on her budget line or inside it.
o Lisa cannot afford any point outside her budget line.
• Budget equation states that: expenditure = income
• Lisa’s budget equation is (p = pop, m = movie): PpQp + PmQm = Y
o PPQP + PMQM = Y
o Divide both sides of this equation by PP, to give:
o QP + (PM/PP)QM = Y/PP
o Then subtract (PM/PP)QM from both sides of the equation to give:
o QP= Y/PP – (PM/PP)QM
o Y/PP is Lisa’s real income in terms of pop.
Real income: what we can afford to buy with our income ($40 income means
nothing without the price of pop - $1 pop = 40 pops vs. $20 pop = 2 pops - $1
pop provides better satisfaction)
o PM/PP is the relative price of a movie in terms of pop.
• A rise in the price of the good on the x-axis decreases the affordable quantity of that good
and increases the slope of the budget line.
o High price = budget line moves left (lesser angle)
o Low price = budget line moves right (greater angle)
o Example: if the price of pop and movies both double, the budget line shifts inward
• A change in $ income brings a parallel shift of the budget line ECON 1000
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o Higher = budget line moves outwards
o Lower = budget line moves inwards
Preferences and Indifference Curves
• Indifference curve: line showing combinations of goods among which a customer is
o Equally satisfied at any point on the indifference curve
• Lisa can sort all possible combinations of goods into three groups: preferred, not preferred,
and just as good as point C. An indifference curve joins all those points that Lisa says are
just as good as C.
• All the points on the indifference curve are preferred to all the points below the indifference
• And all the points abo