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Chapter 5

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Boston College
ECON 2201

Chapter 5 – Choice As you move from right to left along the budget line, you are moving to higher and higher indifference curves, and stop when you get to the highest indifference curve that just touches the budget line. - This point where they touch is labeled ( ) - This is the optimal choice for the consumer because the set of bundles she prefers to her optimal point (the ones above her indifference curve) doesn’t intersect the bundles she can afford (the ones below her budget line) - At this point, the indifference curve is tangent to the budget line Some indifference curves don’t have a tangent point, such as bundles that have a kink point at the optimal choice. Other times, the optimal choice occurs where the consumption of one good is 0. - Implies that while the tangency condition is necessary, it isn’t sufficient However, it is sufficient in the case of convex preferences. Any point that satisfies tangency must be optimal. −P 1 - If the consumer is at a point where they’re willing to stay put, or where MRS = P2 - Whenever the MRS is different from the price ratio, the consumer cannot be at their optimal choice Demanded bundle – the optimal choice of goods 1 and 2 at some set of prices and income is called the consumer’s demanded bundle Demand function – the function that relates the optimal choice (quantities demanded) to the different values of prices and incomes - Written depending on both prices and income, for example x (p , p , m)1an1 x 2p , p , m) 2 1 2 Basic procedure: plot indifference curves and budget line and find the point where the highest indifference curve touches the budget line Perfect substitutes – has three possible cases 1. If p2 > p1, then the slope of the budget line is flatter than the slope of the indifference curve. Here, the optimal
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