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DAMIEN KINGUniversity of the West Indies, J
Consumer
Choice1
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?
?
?
Why does the demand curvedownward?
Think of your favourite restadish. Why do you not have iday?How come higher wages socause people to work less?
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2
1
3
Budget ConstraintWhat you can afford
PreferencesWhat you like
OptimizingMaking the best choice
Outline
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Budget Constraint
What can you affor
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Weekly income = $1,0
Price of a beer = $200 Price of a patty = $100
BudgetInformatio
n
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=All the
combinations of
patties andbeer that
can beafforded
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7
6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
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7
6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
BudgetConstraint
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6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
SueInc
Ri
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7
6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
BeersQuantit
y Co
6 125 104 803 602 401 20
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7
6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
A cinincshthebu
lin
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7
6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
A cinincshthebu
lin
The furtheraway from the
origin, themore youcan afford.
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7
6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
Sue tpr
a pris
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7
6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
BeersQuantit
y Co
5 104 803 602 401 200 0
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7
6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
A c
in chthe
thebulin
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7
6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
MaPra P
(in
= $100 =
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7
6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
MaPra P
(in
The cost of thehorizontal goodequals the slope
of the line.
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7
6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
MaPra P
(in1
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P
YAmount of purchasing powehaveDistance of the line from the originBudget
lineprovides
the
followinginformatio
n
Rate at which you can tradeThe slope of the line
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Preferences
What you like.
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All the
combinations of
patties andbeer
amongstwhich you
are
indifferent
Equally happywith either
bundle
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Thesubjectiv
e valueof a pattychanges 1/3 of a beer
1 beer
2 beers
Marginal Rateof Substitution
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7
6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
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7
6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
Indifference Curve
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IndifferenceCurve
A curve linking all thecombinations of twocommodities that a
consumer regards asproviding equal
satisfaction
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7
6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
MR
sloindce
21
MarginalRate ofSubstitution
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7
6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
Choose a distarting po
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7
6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
Hig
Indcepre
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7
6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
Ind
ce
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An
inde mpa
to pe
This
personlikespatties
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An
inde mpa
to pe
This
personprefersbeer
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7
6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
Co
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7
6
5
4
3
2
1
0
8
1 2 3 4 5 6 7 8 90 10
Do
d s
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No
intng
3
6
2
7
5
4
B
C
A
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Optimizing
Making the best cho
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We know what y
can afford. We kwhat you like. Swhat are youactually going toconsume?
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ThBeCh
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Th
BeCh
1
8
2
6
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Th
BeCh3
4
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FoodHousing Would ha
live in cabox to aflobster
Cant afflobster ahousing
fast food lobster
Monahouse
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Why a gift baske
sub-optimal.
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C3
4
B4
2
GiftBasket
Best useof cash
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Changing Incom
and Prices
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An
Incin
Inc
6
4
7
5
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Income EffectThe effect of a change inpurchasing power on the
quantities of commodities
consumedThe income effect is usually positive
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An
IncinInc
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An
IncinIncInfGo
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Normal v Inferior
GoodWhereas for a normal
good, an increase in
income causes quantityconsumed to rise, for aninferior good,
consumption will fall
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A
ChinRePr(pa
h
A
B
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Substitution EffectThe effect of a change in
relative price on thequantities of commodities
consumedThe substitution effect is always negative
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Inc
Sun E
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A R
theof B
A
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?
?
?
If the price of phone calls goyou spend more or less on cIf the cost of textbooks rises
your spending on entertainmchange?When energy costs fall, is it that people spend less on e
Applicatio
ns ofIncomeand
Substitution Effects
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Suppose studyin
gets easier, do ystudy more or tamore time off?
rs)
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An
Apn tStu
Studying (in pages)
Leisure(inhour
rs)
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Studying (in pages)
Leisure(inhou
Leis
10
9
87
6
5
4
3
21
0
3 pagesper hour
rs)
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Studying (in pages)
Leisure(inhou
Leis
10
9
87
6
5
4
3
21
0
4 pagesper hour
urs)
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Inc
SuonEff
Stu
BA
Studying (in pages)
Leisure(inhou
Subst
Subst
Incom
e
Income
urs)
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Inc
SuonEff
Stu
BA
Studying (in pages)
Leisure(inhou
Subst
Subst
Incom
e
Income
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How would you
respond to a higwage?
on
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9000
8000
7000
6000
5000
4000
3000
20001000
2 4 6 8 10 12 14 160
0
Th
LaLeCh
16 14 12 10 8 6 4 2 0
Leisure
Work
Co
s.
Hours
Money
on
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9000
8000
7000
6000
5000
4000
3000
20001000
2 4 6 8 10 12 14 160
0
16 14 12 10 8 6 4 2 0
Leisure
Work
Co
s.
Wage Rate
on
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9000
8000
7000
6000
5000
4000
3000
20001000
2 4 6 8 10 12 14 160
0
16 14 12 10 8 6 4 2 0
Leisure
Work
Co
s.
Wage Rate
Wage Rate
ons.
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Re
sePaRa
Leisure
Co
Subst
Subst
Incom
e
Income
You willchoose toearn more
Will youchoose to
workmore?
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Consumption choices reflec
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2
1Consumption choices reflechighest level of satisfaction affordability allows.Changes in prices have bothand substitution effects.