THE CONSUMERS BUDGET Let us consider a consumer who has only a fixed amount of

The consumers budget let us consider a consumer who

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THE CONSUMER’S BUDGET Let us consider a consumer who has only a fixed amount of money (income) to spend on two goods. The prices of the goods are given in the market. The consumer cannot buy any and every combination of the two goods that she may want to consume. The consumption
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bundles that are available to the consumer depend on the prices of the two goods and the income of the consumer. Given her fixed income and the prices of the two goods, the consumer can afford to buy only those bundles which cost her less than or equal to her income. Budget Set and Budget Line Suppose the income of the consumer is M and the prices of bananas and mangoes are p1 and p2 respectively5. If the consumer wants to buy x1 quantities of bananas, she will have to spend p1x1 amount of money. Similarly, if the consumer want to buy x2 quantities of mangoes, she will have to spend p2 x2 amount of money. OPTIMAL CHOICE OF THE CONSUMER The budget set consists of all bundles that are available to the consumer. The consumer can choose her consumption bundle from the budget set. But onwhat basis does she choose her consumption bundle from the ones that are available to her? In economics, it is assumed that the consumer chooses herconsumption bundle on the basis of her tatse and preferences over the bundles in the budget set. It is generally assumed that the consumer has well definedpreferences over the set of all possible bundles. She can compare any two bundles. In other words, between any two bundles, she either prefers one to the other or she is indifferent between the two Equality of the Marginal Rate of Substitution and the Ratio of the Prices The optimum bundle of the consumer is located at the point where the budget line is tangent to one of the indifference curves. If the budget lineis tangent to an indifference curve at a point, the absolute value oftheslope of the indifference curve (MRS) and that of the budget
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line(priceratio) are same at that point. Recall from our earlier discussion that theslope of the indifference curve is the rate at which the consumer is willingto substitute one good for the other. The slope of the budget line is therate at which the consumer is able to substitute one good for the otherin the market. At the optimum, the two rates should be the same. To seewhy, consider a point where this is not so.Suppose the MRS at such apoint is 2 and suppose the two goods have the same price. At this point,the consumer is willing to give up 2 mangoes if she is given an extrabanana. But in the market, she can buy an extra banana if she gives upjust 1 mango. 4 DEMAND In the previous section, we studied the choice problem of the consumer and derived the consumer’s optimum bundle given the prices of the goods, theconsumer’s income and her preferences. It was observed that theamount of a good that the consumer chooses optimally, depends on the price of the good itself, the prices of other goods, the consumer’s income and her tastes and preferences. The quantity of a
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