7 topics for further study. copyright © 2006 thomson learning 21 the theory of consumer choice
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7
TOPICS FOR FURTHER STUDY
Copyright © 2006 Thomson Learning
2121The Theory of Consumer Choice
Copyright © 2006 Thomson Learning
The Consumer’s Budget Constraint
Figure 1 The Consumer’s Budget Constraint
Quantityof Pizza
Quantityof Pepsi
0
Consumer’sbudget constraint
500B
100
A
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Figure 1 The Consumer’s Budget Constraint
Quantityof Pizza
Quantityof Pepsi
0
Consumer’sbudget constraint
500B
250
50
C
100
A
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Figure 2 The Consumer’s Preferences
Quantityof Pizza
Quantityof Pepsi
0
Indifferencecurve, I1
I2
C
B
A
D
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Figure 2 The Consumer’s Preferences
Quantityof Pizza
Quantityof Pepsi
0
Indifferencecurve, I1
I21
MRS
C
B
A
D
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Figure 2 The Consumer’s Preferences
Quantityof Pizza
Quantityof Pepsi
0
Indifferencecurve, I1
I2
C
B
A
D
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Figure 2 The Consumer’s Preferences
Quantityof Pizza
Quantityof Pepsi
0
Indifferencecurve, I1
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Figure 3 The Impossibility of Intersecting Indifference Curves
Quantityof Pizza
Quantityof Pepsi
0
C
A
B
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Figure 4 Bowed Indifference Curves
Quantityof Pizza
Quantityof Pepsi
0
Indifferencecurve
8
3
A
3
7
B
1
MRS = 6
1MRS = 14
6
14
2
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Figure 5 Perfect Substitutes and Perfect Complements
50p coins0
10p coins
(a) Perfect Substitutes
I1 I2 I3
3
15
2
10
1
5
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Figure 5 Perfect Substitutes and Perfect Complements
Right Shoes0
LeftShoes
(b) Perfect Complements
I1
I2
7
7
5
5
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Figure 6 The Consumer’s Optimum
Quantityof Pizza
Quantityof Pepsi
0
Budget constraint
I1I2
I3
Optimum
AB
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Figure 7 An Increase in Income
Quantityof Pizza
Quantityof Pepsi
0
New budget constraint
I1
I2
2. . . . raising pizza consumption . . .
3. . . . andPepsiconsumption.
Initialbudgetconstraint
1. An increase in income shifts thebudget constraint outward . . .
Initialoptimum
New optimum
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Figure 8 An Inferior Good
Quantityof Pizza
Quantityof Pepsi
0
Initialbudgetconstraint
New budget constraint
I1 I2
1. When an increase in income shifts thebudget constraint outward . . .3. . . . but
Pepsiconsumptionfalls, makingPepsi aninferior good.
2. . . . pizza consumption rises, making pizza a normal good . . .
Initialoptimum
New optimum
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Figure 9 A Change in Price
Quantityof Pizza
Quantityof Pepsi
0
1,000 D
500 B
100
A
I1I2
Initial optimum
New budget constraint
Initialbudgetconstraint
1. A fall in the price of Pepsi rotates the budget constraint outward . . .
3. . . . andraising Pepsiconsumption.
2. . . . reducing pizza consumption . . .
New optimum
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Figure 10 Income and Substitution Effects
Quantityof Pizza
Quantityof Pepsi
0
I1
I2A
Initial optimum
New budget constraint
Initialbudgetconstraint
Substitutioneffect
Substitution effect
Incomeeffect
Income effect
B
C New optimum
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Table 1 Income and Substitution Effects When the Price of Pepsi Falls
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Figure 11 Deriving the Demand Curve
Quantityof Pizza
0
Demand
(a) The Consumer’s Optimum
Quantityof Pepsi
0
Price ofPepsi
(b) The Demand Curve for Pepsi
Quantityof Pepsi
250
$2A
750
1B
I1
I2
New budget constraint
Initial budget constraint
750 B
250A
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Figure 12 A Giffen Good
Quantityof Meat
Quantity ofPotatoes
0
I2I1
Initial budget constraint
New budgetconstraint
D
A
B
2. . . . which increasespotatoconsumptionif potatoesare a Giffengood.
Optimum with lowprice of potatoes
Optimum with highprice of potatoes
E
C1. An increase in the price ofpotatoes rotates the budgetconstraint inward . . .
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Figure 13 The Work-Leisure Decision
Hours of Leisure0
Consumption
€ 5,000
100
I3
I2
I1
Optimum
2,000
60
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Figure 14 An Increase in the Wage
Hours ofLeisure
0
Consumption
(a) For a person with these preferences . . .
Hours of LaborSupplied
0
Wage
. . . the labor supply curve slopes upward.
I1
I2BC2
BC1
2. . . . hours of leisure decrease . . . 3. . . . and hours of labor increase.
1. When the wage rises . . .
Labor supply
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Figure 14 An Increase in the Wage
Hours ofLeisure
0
Consumption
(b) For a person with these preferences . . .
Hours of LaborSupplied
0
Wage
. . . the labor supply curve slopes backward.
I1
I2
BC2
BC1
1. When the wage rises . . .
2. . . . hours of leisure increase . . . 3. . . . and hours of labor decrease.
Labor supply
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Figure 15 The Consumption-Saving Decision
Consumptionwhen Young
0
Consumptionwhen Old
€ 110,000
100,000
I3
I2
I1
Budgetconstraint
55,000
€ 50,000
Optimum
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Figure 16 An Increase in the Interest Rate
0
(a) Higher Interest Rate Raises Saving (b) Higher Interest Rate Lowers Saving
Consumptionwhen Old
I1
I2
BC1
BC2
0
I1 I2
BC1
BC2
Consumptionwhen Old
Consumptionwhen Young
1. A higher interest rate rotatesthe budget constraint outward . . .
1. A higher interest rate rotatesthe budget constraint outward . . .
2. . . . resulting in lowerconsumption when young and, thus, higher saving.
2. . . . resulting in higherconsumption when youngand, thus, lower saving.
Consumptionwhen Young
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