Microeconomics 12/10/22

 The theory of consumer choice

People face tradeoffs

- Buying more of one good leaves less income to buy other goods

Budget constraint: 

- The limit on the consumption bundles that a consumer can afford

Example:

- Hurley divides his income between two goods: fish and mangos.

- A “consumption bundle” is a particular combination of the goods, e.g., 40 fish & 300 mangos

A fall in the price of fish has two effects on Hurley’s optimal consumption of both goods

- Substitution effect

    - A fall in PF makes mangos more expensive relative to fish: Hurley buys fewer mangos and more fish

- Income effect

    - A fall in PF boosts the purchasing power of Hurley’s income: buy more mangos and more fish

The net effect on mangos is ambiguous