Microeconomics

The Theory of Consumer Choice

Presenters:
Haleema Zahid
Mishaal Gill
Ilyeen Raza
THE BUDGET CONSTRAINT: WHAT THE
CONSUMER CAN AFFORD
The budget constraint depicts the limit on the consumption “bundles”
that a consumer can afford.
• People consume less than they desire because their
spending is constrained, or limited, by their income.

• The budget constraint shows the various combinations of

goods the consumer can afford given his or her income and
the prices of the two goods.
 The Consumer’s Budget Constraint
Pints of Number of Spending on Spending on Total
Pepsi Pizzas Pepsi Pizza Spending
0 100 $ 0 $ 1,000 $ 1,000
50 90 100 900 1,000
100 80 200 800 1,000
150 70 300 700 1,000
200 60 400 600 1,000
250 50 500 500 1,000
300 40 600 400 1,000
350 30 700 300 1,000
400 20 800 200 1,000
450 10 900 100 1,000
500 0 1,000 0 1,000
 Budget Constraint
The budget constraint represents all the possible
combinations of two or more goods that a consumer can
purchase, given current prices and their budget.

• For example, if the consumer buys no

pizzas, he can afford 500 pints of Pepsi
(point B). If he buys no Pepsi, he can
afford 100 pizzas (point A).
Figure of Consumer Budget Constraint
Quantity of
Pepsi
500

Bu
Co et C
dg
ns on
um st
er r ai n
’s t
0
100 Quantity of
Pizza
Alternately, the Quantity of
Pepsi

consumer can B

Bu
500

Co et C
dg
ns on
um st
buy 50 pizzas

er r ai n
C

’s
250

and 250 pints of

t
A

Pepsi.
0
50 100 Quantity of
Pizza
Consumer Budget Constraint
The slope of the budget constraint line equals the relative
price of the two goods, that is, the price of one good
compared to the price of the other.
• It measures the rate at which the consumer
can trade one good for the other.

• A consumer’s preference among

consumption bundles may be illustrated
with indifference curves.
 Representing Preferences with Indifference Curves

An Indifference curve is a curve that shows consumption bundles that

give the consumer the same level of satisfaction.
Quantity of Pepsi

I2

Indifference
Curve I1
Quantity of Pizza
0
The Consumer’s Preferences
The consumer is indifferent, or equally happy, with
the combinations shown at points A, B, and C
because they are all on the same curve.

The Marginal Rate of Substitution

The slope at any point on an indifference curve is
the marginal rate of substitution.
• It is the rate at which a consumer is
willing to trade one good for another
• It is the amount of one good that a
consumer requires as compensation to give
up one unit of the other good.
Four Properties of Indifference Curve
Higher indifference Indifference curves
curves are preferred to are downward
lower ones. sloping.

Indifference
Indifference curves curves are bowed
do not cross. inward.
Property 1: Higher indifference curves are preferred
to lower ones.

• Higher indifference
• Consumers usually curves represent larger
prefer more of quantities of goods than
something to less of it. do lower indifference
curves.
Property 2: Indifference curves are downward sloping

● A consumer is willing to give up one ● If the quantity of one good is reduced,

good only if he or she gets more of the the quantity of the other good must
other good in order to remain equally increase.
happy.

● For this reason, most indifference

curves slope downward.
 Property 3: Indifference curves do not
cross.

• Points A and B should make the • Points B and C should make the
consumer equally happy. consumer equally happy.

• This implies that A and C would • But C has more of both goods
make the consumer equally happy. compared to A.
Property 4: Indifference curves are bowed inward.

● People are more willing to ● These differences in a

trade away goods that they have consumer’s marginal
in abundance and less willing to substitution rates cause his or
trade away goods of which they her indifference curve to bow
have little. inward.
Two Extreme Examples of Indifference Curves

• Perfect substitutes
• Perfect complements
 Perfect substitutes & Perfect complements

Perfect substitutes Perfect complements

Two goods with straight-line Two goods with right-

indifference curves are perfect angle indifference curves
substitutes. are perfect complements.
• The marginal rate of substitution is a
fixed number.
OPTIMIZATION: WHAT THE CONSUMER CHOOSES
• Consumers want to get the
combination of goods on the highest
possible indifference curve.
• However, the consumer must also
end up on or below his budget
constraint.
 The Consumer’s Optimal Choices

• Consumer optimum occurs at the

• Combining the indifference curve point where the highest indifference
and the budget constraint determines curve and the budget constraint are
the consumer’s optimal choice. tangent.

• At the consumer’s optimum, the

consumer’s valuation of the two
goods equals the market’s valuation.
How Changes in Income Affect the Consumer’s Choices

• An increase in income shifts the budget constraint

outward.
• The consumer is able to choose a better
combination of goods on a higher indifference
curve.
 Normal versus Inferior Goods
• If a consumer buys less of a good
• If a consumer buys more of a good
when his or her income rises,
when his or her income rises, the
the good is called an inferior
good is called a normal good.
good.
Awesome words
A picture is
worth a
thousand words
135,789
Mars is full of iron oxide dust

+25%
Earth is the planet with life

$120
Venus has a toxic atmosphere
 Project schedule
January February March April May June

Phase 1
Jan 1 - Mar 1

Task 1
Jan 1 - 27

Task 2
Feb 1 - Mar 25

Phase 2
Apr 1 - Jun 25

Task 1
April 1 - 23
 Project timeline
Phase 1 Phase 2
Mercury is the closest planet
Venus is the second planet to the Sun
from the Sun

01 02 03 04

Despite being red, Mars is Jupiter is the biggest planet in

actually a very cold place the Solar System

Phase 2 Phase 4
 This is a map

Main locations
Earth is the third planet from
the Sun and the only one that
harbors life in the Solar
System
Meeting calendar of the month
MAY

M Tu W Th F
Mars
2 3 4 5 6

9 10 11 12 13 Venus

16 17 18 19 20
Jupiter
23 24 25 26 27

30 31
 KPI dashboard
GLOBAL ANNUAL RESULTS RESULTS BY MONTH

People 70%

Sales 80%

Market 60%

To modify this graph, click on it, follow the link, change the data and
paste the new graph here, replacing this one
 Status report
Schedule The project schedule is mostly on track

Resourcing Resourcing is adequate

Budget Project is within budget

Risks Most project risks are under control

Issues Project issues need to be solved

 RAID summary
RISKS ASSUMPTIONS
Neptune is the farthest planet Despite being red, Mars is a cold
from the Sun place

ISSUES DEPENDENCIES

Mercury is the closest planet to Jupiter is the biggest planet in

the Sun the Solar System
 Where we Where we want
are to be
Mercury is the closest planet to the Sun and the Venus has a beautiful name and is the second
smallest one in the Solar System—it’s only a bit planet from the Sun. It’s terribly hot—even
larger than the Moon. The planet’s name has hotter than Mercury—and its atmosphere is
nothing to do with the liquid metal, since extremely poisonous. It’s the second-brightest
Mercury was named after the Roman messenger natural object in the night sky after the Moon
god
 Upcoming events

Mercury Venus Mars

Mercury is the closest planet Venus has a beautiful name Despite being red, Mars is
to the Sun and the smallest and is the second planet from actually a very cold place.
one in the Solar System—it’s the Sun. It’s terribly hot, It’s full of iron oxide dust,
only a bit larger than the even hotter than Mercury which gives the planet its
Moon reddish cast
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