income and spending. To keep things simple, we examine the decision facing a consumer who buys only two goods: pizza and Pepsi. Of course, real people buy
thousands of different kinds of goods. Assuming there are only two goods greatly simplifies the problem without altering the basic insights about consumer choice. We first consider how the consumer's income constrains the amount he spends on pizza and Pepsi. Suppose the consumer has an income of $1,000 per month and he spends his entire income on pizza and Pepsi. The price of a pizza is $10, and the price of a pint of Pepsi is $2. The table in Figure 1 shows some of the many combinations of pizza and Pepsi that the consumer can buy. The first row in the table shows that if the consumer spends all his income on pizza, he can eat 100 pizzas during the month, but he would not be able to buy any Pepsi at all. The second row shows another possible consumption bundle: 90 pizzas and 50 pints of Pepsi. And so on. Each consumption bundle in the table costs exactly $1,000. The graph in Figure 1 illustrates the consumption bundles that the consumer can choose. The vertical axis measures the number of pints of Pepsi, and the horizontal axis measures the number of pizzas. Three points are marked on this figure. At point A, the consumer buys no Pepsi and consumes 100 pizzas. At point B, the consumer buys no pizza and consumes 500 pints of Pepsi. At point C, the consumer buys 50 pizzas and 250 pints of Pepsi. Point C, which is exactly at the middle of the line from A to B, is the point at which the consumer spends an equal consumption bundles that of pizza and Pepsi that the consumer can choose. All the points on the line from A a consumer can afford to B are possible. This line, called the budget constraint , shows the consumption bundles that the consumer can afford. In this case, it shows the trade-off between pizza and Pepsi that the consumer faces.
The slope of the budget constraint measures the rate at which the consumer can trade one good for the other. Recall that the slope between two points is calculated as the change in the vertical distance divided by the change in the horizontal distance (“rise over run”). From point A to point B, the vertical distance is 500 pints, and the horizontal distance is 100 pizzas. Thus, the slope is 5 pints per pizza. (Actually, because the budget constraint slopes downward, the slope is a negative number. But for our purposes, we can ignore the minus sign.) Notice that the slope of the budget constraint equals the relative price
- Spring '14
- Microeconomics, Consumer, indifference curves, Pepsi.