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Micro ch21 Presentation
Micro ch21 Presentation
21
The Theory of
Consumer Choice
Microeonomics
PRINCIPLES OF
N. Gregory Mankiw
Slope = – 4 D
Hurley must
give up
4 mangos
to get one fish.
Quantity
of Fish
THE THEORY OF CONSUMER CHOICE 7
The Slope of the Budget Constraint
The slope of the budget constraint equals
the rate at which Hurley
can trade mangos for fish
the opportunity cost of fish in terms of mangos
the relative price of fish:
9
ACTIVE LEARNING 2
Answers, part A
Quantity A
A fall
fall in
in income
income
Now, of Mangos shifts
shifts the
the budget
budget
Hurley constraint
constraint down.
down.
can buy
$800/$4
= 200 fish
or
$800/$1
= 800 mangos
or any
combination in
between. Quantity
of Fish
ACTIVE LEARNING 2
Answers, part B
Quantity An
An increase
increase in
in the
the
Hurley of Mangos price
price of
of one
one good
good
can still buy pivots
pivots the
the budget
budget
300 fish. constraint
constraint inward.
inward.
But now he
can only buy
$1200/$2 =
600 mangos.
Notice:
slope is smaller,
relative price of
fish is now only
2 mangos. Quantity
of Fish
Preferences: What the Consumer Wants
If the quantity of
B
fish is reduced,
the quantity of A
mangos must be
I1
increased to keep
Hurley equally
happy. Quantity
of Fish
Quantity Hurley’s
3. Indifference curves of Mangos indifference curves
cannot cross.
Suppose they did.
Hurley should prefer
B to C, since B has B
more of both goods.
Yet, Hurley is indifferent C A
between B and C: I1 I4
He likes C as much as A
(both are on I4).
Quantity
He likes A as much as B of Fish
(both are on I1).
THE THEORY OF CONSUMER CHOICE 15
Four Properties of Indifference Curves
Quantity
4. Indifference curves of Mangos
are bowed inward.
A
Hurley is willing to give
up more mangos for a 6
fish if he has few fish
1
(A) than if he has
B
many (B). 2
1 I1
Quantity
of Fish
Quantity Indifference
Indifference Quantity Indifference
Indifference
curves of hot curves
curves for
of Pepsi curves for
for close
close dog buns
for
substitutes
substitutes are
are close
close
not
not very
very bowed
bowed complements
complements
are
are very
very
bowed
bowed
Quantity Quantity
of Coke of hot dogs
Optimization: What the Consumer Chooses
A is the optimum: Quantity
of Mangos
The
The optimum
optimum
the point on the
is
is the
the bundle
bundle
budget constraint
Hurley
Hurley most
most
that touches the
1200 prefers
prefers outout of
of
highest possible
all
all the
the bundles
bundles
indifference curve.
he
he cancan afford.
afford.
Hurley prefers B to A, B
but he cannot afford B. 600
A
marginal
price of fish
value of fish
(in terms of
mangos)
(in terms of 150 300 Quantity
mangos) of Fish
THE THEORY OF CONSUMER CHOICE 22
The Effects of an Increase in Income
Quantity
of Mangos
An increase in
income shifts the
budget constraint
outward.
B
If both goods are A
“normal,” Hurley
buys more of each.
Quantity
of Fish
THE THEORY OF CONSUMER CHOICE 23
ACTIVE LEARNING 3
Inferior vs. normal goods
An increase in income increases the quantity
demanded of normal goods and reduces the
quantity demanded of inferior goods.
Suppose fish is a normal good
but mangos are an inferior good.
Use a diagram to show the effects of
an increase in income on Hurley’s optimal
bundle of fish and mangos.
24
ACTIVE LEARNING 3
Answers Quantity
of Mangos
If mangos are
inferior, the new
optimum will
contain fewer
mangos.
A
B
Quantity
of Fish
25
The Effects of a Price Change
Quantity
Initially,
of Mangos
PF = $4
1200
PM = $1 initial
optimum
PF falls to $2 new
optimum
budget constraint 600
500
rotates outward,
Hurley buys
more fish and
fewer mangos.
150 300 600 Quantity
350 of Fish
29
ACTIVE LEARNING 4
Answers
But
ButInthe
Inthe substitution
both graphs,
graphs, the
substitution
both effect
effect
the is
is bigger
relative
relative pricefor
price
bigger substitutes
changes
for substitutes
changes
bythan
by the
than complements.
the same amount.
complements.
same amount.
Quantity
of Pepsi Quantity of
hot dog buns
A
B B
Quantity Quantity
of Coke of hot dogs
Deriving Hurley’s Demand Curve for Fish
A: When
B: $4, Hurley
WhenPPF F==$2, Hurley demands
demands 350
150 fish.
fish.
Quantity Price of
of Mangos Fish
A
$4
A
B
B
$2
DFish
At
At the
the optimum,
optimum,
the
the MRS
MRS between
between
current
current and
and future
future
consumption
consumption equals
equals
the
the interest
interest rate.
rate.
42
ACTIVE LEARNING 5
Answers
The interest rate rises.
Substitution effect
Current consumption becomes more expensive
relative to future consumption.
Current consumption falls, saving rises,
future consumption rises.
Income effect
Can afford more consumption in both the
present and the future. Saving falls.
43
Application 3: Interest Rates and Saving
In
In this
this case,
case,
SE
SE >> IEIE and
and
saving
saving rises
rises
47
CHAPTER SUMMARY
49
CHAPTER SUMMARY
51