This document discusses consumer behavior and how consumers make choices based on their budget constraints and preferences. It covers the key concepts of budget lines, indifference curves, marginal rates of substitution, and how consumer choices are impacted by changes in income and prices. The budget line shows the combinations of goods a consumer can afford given their income, while indifference curves represent bundles of goods that make the consumer equally satisfied. Changes in income shift the budget line, allowing the consumer to achieve a higher indifference curve. Changes in prices rotate and change the slope of the budget line, impacting consumption through income and substitution effects.

1. Consumer Behavior
Ch. 7

2. The Budget Line
The budget line depicts the
consumption “bundles” that a
consumer can afford.
People consume less than they desire because
their spending is constrained, or limited, by
their income.

3. The Consumer’s Budget Line...
Quantity
of Pepsi
500
250
B
C
Consumer’s
Budget line
0
50
A
100
Quantity
of Pizza

4. The Consumer’s Budget Line
The slope of the budget line equals
the relative price of the two goods,
that is, the price of one good
compared to the price of the other.
It measures the rate at which the
consumer will trade one good for the
other.

5. Preferences:
What the Consumer Wants
A consumer’s preference
among consumption bundles
may be illustrated with
indifference curves.
An indifference curve shows
bundles of goods that make the
consumer equally happy.

6. The Consumer’s Preferences...
Quantity
of Pepsi
C
B
D
I2
A
0
Indifference
curve, I 1
Quantity
of Pizza

7. The Consumer’s Preferences
The consumer is indifferent, or equally
happy, with the combinations shown at
points A, B, and C because they are all on
the same curve.

8. The Marginal Rate of
Substitution
The slope at any point on an indifference
curve is the marginal rate of
substitution.
It is the rate at which a consumer is willing
to substitute one good for another.
It is the amount of one good that a
consumer requires as compensation to give
up one unit of the other good.

9. The Consumer’s Preferences...
Quantity
of Pepsi
C
B
D
I2
MRS 1
A
0
Indifference
curve, I 1
Quantity
of Pizza

10. Properties of Indifference
Curves
Higher indifference curves are
preferred to lower ones.
Indifference curves are
downward sloping.
Indifference curves do not cross.
Indifference curves are bowed
inward.

11. Property 1: Higher indifference
curves are preferred to lower
ones.
Consumers usually prefer more of
something to less of it.
Higher indifference curves represent
larger quantities of goods than do
lower indifference curves.

12. Property 2: Indifference curves
are downward sloping.
A consumer is willing to give up one
good only if he or she gets more of the
other good in order to remain equally
happy.
If the quantity of one good is reduced,
the quantity of the other good must
increase.
For this reason, most indifference
curves slope downward.

13. Property 3: Indifference curves do
not cross.
Quantity
of Pepsi
C
A
B
0
Quantity
of Pizza

14. Property 4: Indifference curves
are bowed inward.
People are more willing to
trade away goods that they
have in abundance and less
willing to trade away goods of
which they have little.
Quantity
of Pepsi
14
MRS = 6
8
A
1
4
3
0
MRS = 1
2
3
1
6
B
7
Indifference
curve
Quantity
of Pizza

15. Perfect Substitutes
Nickels
6
4
2
0
I1
1
I2
2
I3
3
Dimes

16. Perfect Complements
Left
Shoes
7
I2
5
I1
0
5
7
Right Shoes

17. The Consumer’s Optimum...
Quantity
of Pepsi
Optimum
B
A
I3
I1
I2
Budget constraint
0
Quantity
of Pizza

18. How Changes in Income Affect
the Consumer’s Choices
An increase in income shifts the
budget line outward.
The consumer is able to choose a better
combination of goods on a higher
indifference curve.

19. An Increase in Income...
Quantity
of Pepsi
New budget line
1. An increase in income shifts
the budget line outward…
New optimum
3. …and Pepsi
consumption.
Initial
optimum
Initial
budget line
I2
I1
0
2. …raising pizza
Quantity
of Pizza

20. How Changes in Prices Affect
Consumer Choices
A fall in the price of any
good rotates the budget
constraint outward and
changes the slope of the
budget line.

21. Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
A Change in Price...
Quantity
of Pepsi
1,000
3. …and
raising Pepsi
consumption.
500
Initial budget
constraint
0
New budget constraint
New optimum 1. A fall in the price of Pepsi
rotates the budget constraint
outward…
I2
I1
100
Quantity of Pizza
2. …reducing pizza consumption…

22. Income and Substitution
Effects
A price change has two effects on
consumption.
An income effect
A substitution effect
The income effect is the change in consumption that
results when a price change moves the consumer to a
higher or lower indifference curve.
The substitution effect is the change in consumption
that results when a price change moves the consumer
along an indifference curve to a point with a different
marginal rate of substitution.

23. The new optimum is
Eb on I2.
X2
The Total Price
Effect is xa to xb
Ea
Eb
I2
I1
xa
xb
X1

24. Draw a line parallel to
the new budget line and
tangent to the old
indifference curve
X2
Ea
Eb
I2
I1
xa
xb
X1

25. X2
Ea
The new optimum on I1 is
at Ec. The movement from
Ea to Ec (the increase in
quantity demanded from
Xa to Xc) is solely in
response to a change in
Eb
relative prices
I2
Ec I1
xa xc
xb
X1

26. This is the
substitution effect.
X2
Ea
Xa
Eb
Ec
Substitution
Effect
I2
I1
Xc
X1

27. A Change in Price:
Substitution Effect
The substituiton effect
increases the quantity
demanded of a good whose
price has fallen and reduces
the quantity demanded of a
good whose price has risen.

28. A Change in Price:
Income Effect
The income effect leads
consumers to buy more of a
product whose price has fallen, if
it is a normal good.

29. Because of the combined operation of the
income and substitution effects, the
demand curve for any normal good will be
negatively sloped.