The contents are; The budget constraint- what the consumer can afford. Preferences- what the consumer wants Optimization- what the consumer chooses Three applications Summary/conclusion

2.  The budget constraint- what the consumer
can afford.
 Preferences- what the consumer wants
 Optimization- what the consumer chooses
 Three applications
 Summary/conclusion

3.  The budget constraint depicts the limit on the consumption "bundles" that
a consumer can afford
 people consume less than they desire because their spending is
constraint, or limited, by their income
 The budget constraint shows the various combinations of goods the
consumer can afford given his or her income and the prices of the two
goods.

5.  Any point on the budget constraint
line indicates the consumer's
combination or trade off between two
goods.
 For example, if the consumer buys
no pizzas, he can afford 500 points of
Pepsi (point B).
 If he buys no Pepsi, he can afford
100 pizzas (point A)

6.  Alternately, the consumer can
buy 50 pizzas and 250 points
of Pepsi.
 The slope of the budget
constraint 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 can trade one
good for the other.

7.  A consumer’s preference
among consumption bundles
may be illustrated with
indifference curves
 An indifference curve is a
curve that shows
consumption bundles that
give the consumer the same
level of satisfaction

8.  The consumers preferences- the consumer is indifferent, equally happy
with the points shown at A, B and C because they are all on the same
curve
 The Marginal Rate of Substitution (MRS): the slope at any point on an
indifference curve is called the MRS.
 the rate at which a consumer is willing to trade one good for another
 In this example; the MRS measures how much Pepsi is enough for the
consumer to be compensated for a one unit reduction in pizza that he or
she will be consuming

9.  Property 1: Higher indifference curves are
preferred to lower ones
 Property 2: Indifference curves are downward
sloping
 Property 3: Indifference curves do not cross
 Property 4: Indifference curves are bowed
inwards

10. Perfect substitutes Perfect complements

11.  Consumers want to get the best
combination on the highest possible
indifference curve
 But has to end up either on or below his
or her budget restraint
 Combining the indifference curve and the
consumer’s budget constraint determines
the consumer’s optimal choice
 This consumer optimum point occurs at
the point where the highest indifference
curve and the budget constraint are
tangent

12.  An increase in income will
definitely shift the budget
constraint outward, this means the
consumer is now able to purchase
a better combination of goods on
the higher indifference curve
 Normal vs. inferior goods- if a
consumer buys more of a good
due to a rise in income, it is a
normal good. However if he buys
less of it, it is an inferior good.

13. A price change has two effects on
consumption
1. Income effect
1. Substitution effect

14.  Do all demand curves slope
downwards? – sometimes, they can
slope upward. This happens when
an individual/ consumer buys more
of a good when its price rises
 Giffen goods- a good that violates
the laws of demand
 price increase = increase in
demand
 The income effect dominates the
substitution effect
 They have demand curves that
slope upward

15.  If the substitution affect is
dominant over the income
affect, he or she has to
work more
 If the income affect is
dominant over the
substitution affect, he or
she works less

17.  If the substitution affect of a
higher interest rate is greater
than the income affect,
households save more
 If the income affect of a higher
interest rate is greater than the
substitution affect, households
save less

18.  Thus, an increase in the interest rate could either encourage or discourage
saving

19.  A consumer’s budget constraints shows the possible
combination of different goods he can buy given his income and
the prices of the goods
 The slope of the budget constraints equals the relative price of
the goods
 The consumer’s indifference curves represent his preferences
 Points on higher indifference curves are given more preference
to points on lower indifference curves

20.  The slope of an indifference curve at any point is the marginal
rate of substitution
 The consumer optimizes by choosing the point on his budget
constraint that lies on the highest indifference curve
 When the price of the good falls, the impact on the consumer’s
choices can be broken down into an income affect and a
substitution affect
 The income affect is the change in consumption that arises
because a lower price makes the consumer better off
 The income affect is reflected by the movement from a lower to
a higher indifference curve

21.  The substitution affect is the change in consumption
that arises because a price change encourages greater
consumption of the good that becomes relatively
cheaper
 The substitution effect is reflected by a movement
along an indifference curve to a point with a different
slope
 The theory of consumer can potentially slope upward
 How wages affect labor supply
 How interest rates affect household saving