CHAPTER_9 - CHAPTER9:POSSIBILITIES,PREFERENCESANDCHOICES 1.

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CHAPTER 9: POSSIBILITIES, PREFERENCES AND CHOICES 1. Consumption Possibilities Budget line Budget equation Real income Relative price 3. Preferences and Indifference Curves Indifference curve Indifference map Properties of indifference curve - negative slope (usually) - never cross each other - convex to the origin (diminishing MRS) 4. Degree of substitutability - perfect complements 5. Predicting Consumer Choices - best affordable choice - a change in price - a change in income     7. Work leisure choices & the Labour supply curve
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I. Consumption Possibilities A. Household consumption choices are constrained by its income and the  prices of the goods and services available. The  budget line  describes  the limits to the household’s consumption choices.  Figure 1 shows a consumer’s budget line. 1. Divisible goods  can be bought in any quantity desired (gasoline, for  example) 2. Indivisible   goods   must   be   bought   in   whole   units   (movies,   for  instance). B. The Budget Equation
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1. We can describe the budget line by using a  budget equation,  which  states that income equals expenditure.  a) Calling the price of pop  P P , the quantity of pop  Q P , the price of  a movie  P M , the quantity of movies  Q M , and income  Y , we can  write Lisa’s budget equation as P P Q P  + P M Q M  = Y, which can be rearranged as Q p  =  Y / P P  –  P M / P p   ×   Q M . 2. A household’s  real income  is the household’s income expressed as  a quantity of goods the household can afford to buy. For example,  the   vertical   intercept   for   the   above   budget   line,   Y / P P ,   is   the  consumer’s real income in terms of pop. 3. A  relative price  is the price of one good divided by the price of  another good. For example, the magnitude of the   slope   of the  budget line,  P M / P P   is the relative price of a movie in terms of pop.  This relative price shows how much pop must be forgone to see an  additional movie. 4. The budget line slope is reflects the rate at which one good can be  substituted for another good while keeping the level of income  unchanged. The budget line changes if the relative price of a good  changes or shifts if the household’s income changes. a) A fall in the price of the good on the horizontal (vertical) axis 
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This note was uploaded on 12/31/2011 for the course ECON 101 taught by Professor Vanderwaal during the Fall '08 term at Waterloo.

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CHAPTER_9 - CHAPTER9:POSSIBILITIES,PREFERENCESANDCHOICES 1.

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