ECON 401 Chapter Notes - Chapter 5: Budget Constraint, Indifference Curve, Tangent

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Chapter 5: Choice

• Combining budget set and the theory of preferences in order to examine the optimal

choice of consumers

• Consumer choose the most preferred bundle from their budget sets

5.1 Optimal Choice

• Find the bundle in the budget set that is on the highest indifference curve.

• As you move along the budget line, we move to higher and higher indifference curves

• Optimal choice = 



 = bundle of goods that is associated with the highest

indifference curve that just touches the budget line = where the indifference curve is

tangent to the budget line  normal case called interior optimum (slope of the

indifference curve = slope of the budget line = MRS)

• THE ONLY CASE WHERE TANGENCY IS SUFFICIENT CONDITION FOR THE BUNDLE TO BE

OPTIMAL = STRICTLY CONVEX INDIFFERENCE CURVE OR INTERIOR OPTIMUM

• The set of bundles a consumer prefers to 



 is above the indifference curve and

budget line

• Tagey does’t hold i all ases

o Indifference curve might not have a tangent, but still can never cross the budget

line

o Kinky tastes:

o Boundary optimum:

• What is the indifference curves have multiple tangencies?

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• MRS = slope of udget lie at a iterior optiu… Eooi ipliatios

o MRS = rate of exchange at which the consumer is willing to stay put = 



o BUT whenever the MRS is different to the price ratio, the consumer cannot be at

his or her optimal choice

5.2 Consumer Demand

• Demand bundle: a osuer’s optimal choice of goods 1 and 2 at some set of prices and

income

• Whe pries ad ioe hage, the osuer’s optial hoie ill hage

• Demand function: relates optimal choice – the quantities demanded – to the different

values of prices and incomes

o  and 

o For each set of prices and income, there will be a different combination of goods

that is the optimal choice of the consumer

5.3 Some Examples

• Basic procedure: plot the indifference curves and budget line and find the point where

the highest indifference curve touches the line

Perfect Substitutes

• Optimal choice is where the consumer spends all their money on the cheaper good

• If , there is a whole range of optimal choices – any amount of goods 1 and 2 that

satisfies the budget constraint is optimal

• Demand function for good 1:

o 





















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ECON 401 Full Course Notes

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Document Summary

Chapter 5: choice: combining budget set and the theory of preferences in order to examine the optimal choice of consumers, consumer choose the most preferred bundle from their budget sets. Optimal = strictly convex indifference curve or interior optimum budget line: ta(cid:374)ge(cid:374)(cid:272)y does(cid:374)"t hold i(cid:374) all (cid:272)ases. 5. 3 some examples: basic procedure: plot the indifference curves and budget line and find the point where the highest indifference curve touches the line. Perfect substitutes satisfies the budget constraint is optimal: demand function for good 1, optimal choice is where the consumer spends all their money on the cheaper good. If (cid:2869)=(cid:2870), there is a whole range of optimal choices any amount of goods 1 and 2 that: (cid:1876)(cid:2869)={ (cid:1853)(cid:1866)(cid:1877) (cid:1866)(cid:1873)(cid:1865)(cid:1854)(cid:1857) (cid:1854)(cid:1857)(cid:1872)(cid:1875)(cid:1857)(cid:1857)(cid:1866) 0 (cid:1853)(cid:1866)(cid:1856) (cid:3117)| (cid:1875) (cid:1857)(cid:1866) (cid:2869)=(cid:2870) (cid:3117)| (cid:1875) (cid:1857)(cid:1866) (cid:2869)

Related Questions

True or False. If False explain why it's false.

1. If all prices are doubled an money income is the left the same, the budget set does not change because the relative prices do not change.

2. A decrease in income pivots the budget line around the bundle initially consumed.

3. If preferences are well-behaved, then for any commodity bundle (x1,x2), the set of commodity bundles that are worse than (x1,x2) is a convex set.

4. The marginal rate of substitution measures the distance betwee one indifference curve and the next one.

5. If someone has the utility function U= 2min(x, y), then x and y are perfect complements for that person.

6. At the boundary optimum, a consumers indifference curve must be tangent to her budget line.

7. If two goods are substitutes, then an increase in the price of one of them will increase the demand for the other.

8. An Engel curve is a demand curve with the vertical and horizontal axes reversed.

9. An inferior good is less durable than a normal good.

10. When other variables are held fixed, the demand for a Giffen good rises when income increase.

1. Assume Joseph spends his entire income on X and Y, and his indifference curves have the usual convex shape. If Joseph maximizes his utility, then:

a. he spends his entire available income.

b. there are other bundles that are preferred at the current price ratio

c. the slope of his indifference curve is greater than the slope of his budget line

d. the slope of his indifference curve is smaller than the slope of his budget line

2. The long-run price elasticity of demand for a product is generally___the short-run elasticity for the same product.

a. lower than

b. equal to

c. higher than

d. not comparable to

3. Assume the demand function for skincare products is given by Q = 1,000-20P+5i. if P=$25 and i=$1,000 currently, then:

a. skincare products are a normal good

b. the elasticity of demand is equal to 11

c. skincare products are interior

d. the price is too high

graymosquito823

budget line

marginal utility

complete property of preferences

market demand

consumption bundle

substitution effect

Giffen good

total effect

income effect

transitive property of preferences

indifference curves

utility

the marginal rate of substitution

utility function

1.	_____	The satisfaction or benefit that consumers receive from consuming goods or services.
2.	________________ _	A particular combination of specific quantities of goods or services
3.	________________ _	Consumers can rank all conceivable bundles of goods or services
4.	_____	If A is preferred to B, and B is preferred to C, then A is always preferred to C.
5.	_____	Equation showing a consumerâs perception of the total utility forthcoming from consuming each bundle of goods and services.
6.	_____	A set of consumption bundles each and every one of which provides a consumer with exactly the same level of total utility.
7.	_____	The number of units of Y that must be given up for total utility to remain the same when one more unit of X is consumed.
8.	_____	The addition to total utility attributable to consuming one more unit of a good, holding the consumption of all other goods constant.
9.	_____	The line showing all bundles of goods that can be purchased at given prices if the entire income is spent.
10.	_____	The change in the consumption of a good that would result if the consumer remained on the original indifference curve after the price of the good changes.
11.	_____	The change in consumption of goods results strictly from the change in purchasing power after the price of a good changes.
12.	________________ _	The sum of the substitution and income effects.
13.	_____	A good for which quantity demanded varies directly with price, causing an upward sloping demand curve.
14.	_____	A list of prices and the corresponding quantity consumers are willing and able to purchase at each price.

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ECON 401 Chapter Notes - Chapter 5: Budget Constraint, Indifference Curve, Tangent

ECON 401 Full Course Notes

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