CH 8 econ - Main Concepts: Budget line Preferences and...

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1 Main Concepts: ± Budget line ± Preferences and indifference curves ± Principle of diminishing marginal rate of substitution ± Effects of changes in prices and income on consumption choices ± Substitution and income effect ± Supply of labor Consumption Possibilities The budget line describes the limits to the household’s consumption choices.
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2 Consumption Possibilities The Budget Equation: P a Q a + P b Q b = Y. Or: Q a = Y/P a –( P b /P a )Q b The term Y/P a is real income in terms of good a. The term P b /P a is the relative price of good b in terms of good a. Preferences and Indifference Curves An indifference curve is a line that shows combinations of goods among which a consumer is indifferent .
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3 Preferences and Indifference Curves The marginal rate of substitution , ( MRS ) measures the rate at which a person is willing to give up one good (good y) , to get an additional unit of another good ( x) and at the same time remain indifferent. A
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CH 8 econ - Main Concepts: Budget line Preferences and...

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