Chapter 5 Appendix:
In Chapter 5 we showed why the rational spending rule is a simple consequence
of diminishing marginal utility.
In this appendix, we introduce the concept of
indifference curves to show how the same rule can be developed in another way.
As before, we begin with the assumption that consumers enter the marketplace
with well-defined preferences.
Taking prices as given, their task is to allocate their
incomes to best serve these preferences.
There are two steps required to carry out this
The first is to describe the various combinations of goods the consumer is
These combinations depend, we will see, on both her income level and on the prices
of the goods she faces.
The second step is then to select from among the feasible
combinations, the particular one that she
to all others.
Analysis of this step will
require some means of describing her preferences, in particular a summary of the rank
ordering she assigns to all feasible combinations.
Development of these two elements of
the theory will occupy our attention throughout this appendix.
Because the first
element-- describing the set of possibilities-- is much less abstract than the second, let us
begin with it.
The Budget Constraint
For simplicity, let us begin by considering a world with only two goods,
of goods is the term used to describe a particular combination of food,
measured in pounds per week, and shelter, measured in square yards per week.
Figure A5.1, one bundle (bundle A) might consist of 5 square yards per week of shelter
and 7 pounds per week of food, while another (bundle B) consists of 3 square yards per
week of shelter, 8 pounds per week of food.
For brevity's sake, we may use the notation
(5, 7) to denote bundle A, and (3, 8) to denote bundle B.
More generally, (S
denote the bundle with S
sq yds/wk of shelter and F
lbs/wk of food.
By convention, the
first number of the pair in any bundle represents the good measured along the horizontal
Figure A5.1. Two Bundles of Goods.
A bundle is a specific combination of goods.
Bundle A has 5 units of shelter, 7 units of food.
Bundle B has 3 units of shelter, 8
units of food.
Note that the units on both axes are
, which means physical quantities per
unit of time-- lbs/wk, sq yds/wk.
Consumption is always measured as a flow.
As economists use the term, a "good" may refer to either a product or a service.