Chapter 8 Reading Notes

# Chapter 8 Reading Notes - Chapter Eight Utility and Demand...

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February 26, 2008 Chapter Eight: Utility and Demand Consumption Possibilities Consumption choices are limited by income and by prices Household’s budget line – describes the limits to its consumption choices Divisible goods – can be bought in any quantity desired (i.e., gasoline and electricity) Budget equation describes the budget line o Expenditure=income o Expenditure is equal to the sum of the price of each good multiplied by the quantity bought o P 1 Q 1 + P 2 Q 2 = Y Real income – household’s income expressed as a quantity of goods the household can afford to buy (Y/P 1 ) Relative price – the price of one good divided by the price of another good (aka opportunity cost) When prices change, so does the budget line o The lower the price of the good measured on the horizontal axis, ceteris paribus, the flatter is the budget line. The budget line rotates outward and becomes flatter o The higher the price of the good measured on the horizontal axis, ceteris paribus, the steeper is the budget line. The budget line rotates inward and becomes steeper. A change in money income changes real income but does not change the relative price o The budget line shifts but its slope does not change Preference and Indifference Curves Preference map can be based on combinations of three groups: preferred, not preferred,

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Chapter 8 Reading Notes - Chapter Eight Utility and Demand...

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