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Four key elements in consumer choice
- Consumer’s income
- Prices of goods
- Consumer preferences
- The assumption that consumers maximize utility
The budget line
- Income and prices together determine the combinations of the goods
that the consumer can afford.
- The budget line separates the affordable from the unaffordable.
Modelling consumer preferences
- An indifference curve shows all the consumption bundles that
yield the same utility to the consumer
- ICs slope downwards (given certain assumptions)
- their slope gets steadily flatter to the right
- ICs cannot intersect
Adjustment to an income change
- A change in the consumer’s income shifts the budget line
- without changing the slope
- the change in the pattern of consumer choice depends on the nature
of the two goods
Adjustment to a price change
- An increase in the price of one good shifts the budget line
- altering its slope
- which reflects relative prices.
Response to a price change
- The response to a price change comprises two effects:
- The SUBSTITUTION EFFECT
- is the adjustment to the change in relative prices
- THE INCOME EFFECT
- is the adjustment to the change in real income.
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