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Chapter 9

ECON1000 Chapter 9.doc

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ECON 1000
Ardeshir Noordeh

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Chapter 9: Possibilities, Preferences and Choices Consumption possibilities: Consumption choices are limited by income and by prices. A household’s budget line describes the limits to its consumption choices. Divisible and Indivisible Goods: some goods can be bought in any quantity desired. Examples are gasoline and electricity. Affordable and Unaffordable Quantities: It marks the boundary between what is affordable and what is unaffordable. Budget Equation: We can describe the budget line by using a budget equation. The budget equation starts with the fact that: Expenditure= Income. Expenditure is equal to the sum of the price of each good multiplied by the quantity bought. Expenditure= (price of pop x Quantity of pop) = (Price of movie x Quantity of movies). Call the price of pop Pp the quantity of pop Qp, the price of a movie Pm, the quantity of movies Qm, and income Y. We can now write Lisa’s budget equation as: PpQp + PmQm= Y Real Income: A household’s real income is its income expressed as a quantity of goods that the household can afford to buy. Relative Price: A relative price is the price of one good divided by the price of another good. A Change in Price: When prices change, so does the budget line. The lower the price of the good measured on the x-axis, other things remaining the same, the flatter is the budget line. A Change in Income: A change in money income changes real income but does not change the relative price. The budget line shifts, but its slope does not change. Preferences and Indifference Curves: An indifference curve is a line that shows combinations of goods among which a consumer is indifferent. Marginal Rate of Substitution (MSR): is the rate at which a person will give up good “y” to get an additional unit of good “x” while remaining indifferent (remaining in the same indifference curve). The magnitude of the slope of an indifference curve measures the marginal rate of substitution. o If the indifferent curve is steep, the marginal rate of subs
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