Analyzing Consumer Choice Graphically Budget Lines and Indifference Curves Scarcity Scarcity and and Demand Demand Income Income is is limited limited Consumer Consumer decisions decisions to to purchase purchase different different commodities commodities are are interdependent interdependent Copyright 2006 South Western Thomson Learning All rights reserved Utility Utility A A Tool Tool to to Analyze Analyze Purchase Purchase Decisions Decisions The The Purpose Purpose of of Utility UtilityAnalysis Analysis The The purpose purpose of of utility utility analysis analysis analyzing analyzing how how people people behave behave rather rather than than how how they they think think Theory Theory of of consumer consumer choice choice each each consumer consumer spends spends his his or or her her income income in in aa way way that that yields yields the the greatest greatest satisfaction satisfaction Utility Utility amount amount of of satisfaction satisfaction Copyright 2006 South Western Thomson Learning All rights reserved Utility Utility A A Tool Tool to to Analyze Analyze Purchase Purchase Decisions Decisions Total Total versus versus Marginal Marginal Utility Utility Total Total utility utility benefit benefit to to aa consumer consumer from from all all the the units units of of aa good good purchased purchased Marginal Marginal utility utility benefit benefit from from the the last last unit unit of of aa good good purchased purchased number number of of goods goods purchased purchased total total utility utility but but aa marginal marginal utility utility Copyright 2006 South Western Thomson Learning All rights reserved Utility Utility A A Tool Tool to to Analyze Analyze Purchase Purchase Decisions Decisions The The Law Law of of Diminishing Diminishing Marginal Marginal Utility Utility The The law law of of diminishing diminishing marginal marginal utility utility the the more more of of aa good good aa consumer consumer has has the the less less marginal marginal utility utility an an additional additional unit unit contributes contributes to to overall overall satisfaction satisfaction Additional Additional units units of of aa commodity commodity are are worth worth less less and and less less to to aa consumer consumer in in money money terms terms Copyright 2006 South Western Thomson Learning All rights reserved Geometry Geometry of of Available Available Choices Choices The The Budget Budget Line Line Budget Budget line line Graphical Graphical representation representation of of all all possible possible combinations combinations of of aa household s household s purchases purchases of of two two goods goods given given their their prices prices and and aa fixed fixed amount amount of of money money to to spend spend Properties Properties of of the the Budget Budget Line Line Represents Represents the the maximum maximum amounts amounts of of the the goods goods the the consumer consumer can can afford afford Copyright 2006 South Western Thomson Learning All rights reserved TABLE TABLE 1 1 Alternative Alternative Purchase Purchase Combinations Combinations Copyright 2006 South Western Thomson Learning All rights reserved FIGURE FIGURE 1 1 A A Budget Budget Line Line Pounds of Cheese 7 6 A 5 G B 4 C 3 2 K D 1 0 1 2 3 E 4 5 6 7 Boxes of Rubber Bands Copyright 2006 South Western Thomson Learning All rights reserved Geometry Geometry of of Available Available Choices Choices The The Budget Budget Line Line Changes Changes in in the the Budget Budget Line Line income income parallel parallel shift shift in in the the budget budget line line relative relative prices prices of of the the goods goods slope slope of of the the budget budget line line Copyright 2006 South Western Thomson Learning All rights reserved FIGURE FIGURE 2 2 The The Effect Effect of of Income Income Changes Changes on on the the Budget Budget Line Line 9 U Pounds of Cheese 8 7 6 5 A Income 18 D 4 Income 12 3 Income 9 2 1 0 1 2 N 3 E 4 5 P 6 7 8 Boxes of Rubber Bands Copyright 2006 South Western Thomson Learning All rights reserved FIGURE FIGURE 3 3 The The Effect Effect of of Price Price Changes Changes on on the the Budget Budget Line Line Pounds of Cheese 7 6 A 5 Rubber band price 3 00 Rubber band price 1 50 4 3 2 1 0 1 2 3 E 4 H 5 6 7 8 Boxes of Rubber Bands Copyright 2006 South Western Thomson Learning All rights reserved Properties Properties of of the the Indifference Indifference Curve Curve Indifference Indifference curve curve aa line line connecting connecting all all combinations combinations of of the the goods goods that that are are equally equally desirable desirable Properties Properties of of the the indifference indifference curve curve higher higher isis better better never never intersect intersect negative negative slope slope bowed bowed in in convex convex in in general general Copyright 2006 South Western Thomson Learning All rights reserved FIGURE FIGURE 4 4 33 Indifference Indifference Curves Curves for for Cheese Cheese and and Rubber Rubber Bands Bands Pounds of Cheese 7 6 5 U 4 T 3 2 IC S 1 0 R W 1 2 3 4 Ib Ia 5 6 7 8 Boxes of Rubber Bands Copyright 2006 South Western Thomson Learning All rights reserved The The Slopes Slopes of of Indifference Indifference Curves Curves and and Budget Budget Lines Lines Slope Slope of of the the indifference indifference curve curve marginal marginal rate rate of of substitution substitution of of the the two two goods goods The The slope slope of of the the budget budget line line relative relative prices prices of of the the two two goods goods Copyright 2006 South Western Thomson Learning All rights reserved FIGURE FIGURE 5 5 Slopes Slopes of of aa Budget Budget Line Line and and an an Indifference Indifference Curve Curve I Pounds of Cheese M B R N m D n r E I F B 0 Boxes of Rubber Bands Copyright 2006 South Western Thomson Learning All rights reserved FIGURE FIGURE 6 6 Optimal Optimal Consumer Consumer Choice Choice Pounds of Cheese 7 6 Ic I aI b 5 4 U T 3 2 K 1 0 W 1 2 3 4 5 6 7 Boxes of Rubber Bands Copyright 2006 South Western Thomson Learning All rights reserved The The Slopes Slopes of of Indifference Indifference Curves Curves and and Budget Budget Lines Lines Tangency Tangency Conditions Conditions Utility Utility maximization maximization point point on on the the budget budget line line tangent tangent to to an an indifference indifference curve curve Marginal Marginal rate rate of of substitution substitution price price