BackMicroeconomics: Possibilities, Preferences, and Choices (Chapter 9 Study Notes)
Study Guide - Smart Notes
Tailored notes based on your materials, expanded with key definitions, examples, and context.
Consumption Possibilities
Budget Constraints and the Budget Line
Household consumption choices are limited by income and the prices of goods and services. The budget line represents all possible combinations of two goods that a consumer can afford, given their income and the prices of those goods.
Budget Line: The graphical representation of all affordable combinations of two goods.
Indivisible Goods: Must be purchased in whole units (e.g., cars).
Divisible Goods: Can be purchased in any quantity (e.g., gasoline).
Example: Lisa has $40 to spend. The price of a movie is $8, and the price of cola is $4 per case. The table below lists possible combinations Lisa can afford:
Consumption Possibility | Movies (per month) | Cola (cases per month) |
|---|---|---|
A | 0 | 10 |
B | 1 | 8 |
C | 2 | 6 |
D | 3 | 4 |
E | 4 | 2 |
F | 5 | 0 |
Budget Equation
The budget line can be described mathematically using the budget equation:
Budget Equation:
= Price of cola
= Quantity of cola
= Price of movies
= Quantity of movies
= Income
This equation shows that total expenditure on both goods must equal the consumer's income.
Affordable and Unaffordable Choices
Consumers can afford any combination of goods on or inside the budget line. Combinations outside the budget line are unaffordable.
Affordable Region: All points on or below the budget line.
Unaffordable Region: All points above the budget line.
Example: In the graph, points A through F are affordable combinations for Lisa.
Effects of Changes in Prices and Income
Changes in the price of goods or in income shift or rotate the budget line:
Price Change: A rise in the price of one good decreases the affordable quantity of that good and changes the slope of the budget line.
Income Change: An increase in income shifts the budget line outward (parallel shift), while a decrease shifts it inward. The slope remains unchanged because relative prices do not change.
Formula for Budget Line Slope:
Real Income: The maximum quantity of a good that can be purchased if all income is spent on that good.
Relative Price: The price of one good in terms of another, which determines the opportunity cost of purchasing one good over another.
*Additional info: The above notes expand on the definitions and applications of budget constraints, budget equations, and the effects of price and income changes, as presented in the slides and textbook images.*
