E-201.Study Guide Chapter9. Key Terms and Questions

# E-201.Study Guide Chapter9. Key Terms and Questions -...

This preview shows pages 1–3. Sign up to view the full content.

145 9 POSSIBILITIES, PREFERENCES, AND CHOICES Key Concepts ± Consumption Possibilities The budget line shows the limits to a household’s con- sumption. Figure 9.1 graphs a budget line; the formula for the budget line in this figure is: movies soda movies soda soda Q P P P y Q × = Consumption points beyond the budget line are unaf- fordable; consumption points on and within the budget line are affordable. A household’s real income is the income expressed as a quantity of goods the household can afford to buy. In terms of soda, () yP soda is the household’s real income. An increase in income ( y ) shifts the budget line rightward but does not change its slope. A relative price is the price of one good divided by the price of another. The magnitude of the slope of the budget line PP movies soda is the relative price of a movie in terms of a soda. Changes in the rela- tive price rotate the budget line. A fall in the price of movies, the product on the horizontal axis, ro- tates the budget line outward so that it becomes flat- ter. ± Preferences and Indifference Curves An indifference curve is a curve showing combina- tions of goods among which a person is indifferent. Figure 9.2 illustrates a family of indifference curves. Indifference curves farther from the origin are pre- ferred over those closer to the origin. The marginal rate of substitution ( MRS ) is the rate at which a person is willing to give up the good on the vertical axis (soda) to get an additional unit of the good on the horizontal axis (movies) and still remain indif- ferent. The magnitude of the slope of the indifference curve equals the MRS . Chap ter

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
146 CHAPTER 9 The diminishing marginal rate of substitution is the tendency for a person to be willing to give up less of the good on the vertical axis to get one more unit of the good on the horizontal axis, while re- maining indifferent (that is, on the same indiffer- ence curve) as the quantity of the good on the horizontal axis increases. Goods that are substitutes have straighter indiffer- ence curves; goods that are complements have more bowed indifference curves. ± Predicting Consumer Choice The household chooses the best affordable point for its consumption. This point is the combination of goods on the budget line and on the highest possible indiffer- ence curve. Figure 9.3 illustrates the best affordable point, where the household consumes 2 movies and 2 six-packs of soda per month. At this optimal point: the budget line and indifference curve are tangent so that the marginal rate of substitution equals the relative price. The price effect is the change in the quantity con- sumed of a good resulting from a change in its price. When the price of a movie falls, the budget line rotates as shown in Figure 9.4 and the consumption of movies increases from 2 per month to 2½ per month.
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### Page1 / 18

E-201.Study Guide Chapter9. Key Terms and Questions -...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online