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chapter
Consumer Preferences and
Consumer Choice
1. Following are Isabella’s indifference curve maps for each of the situations described.

a.
Quantity
11
of cars
3 I3

2 I2

1 I1

0 4 8 12
Quantity of tires

b.
Quantity of
Valley Dew
3

1
I1 I2 I3
0 2 4 6
Quantity of cola

c.
Quantity
of income

I2
I1

Quantity of leisure

d.
Quantity
of skis
3 I3

2 I2

1 I1

0 1 2 3 4 5 6
Quantity of bindings

95
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96 CHAPTER 11 CONSUMER PREFERENCES AND CONSUMER CHOICE

e.
Quantity
of soda
I3

I2

I1

Quantity of water

2. a. Bundle B has more movie tickets and more cafeteria meals than bundle A and
therefore it is preferred. The reason is that more is better.
b. Compared to bundle A, bundle B has the same number of cafeteria meals but
more movie tickets. Again, because more is better, bundle B is preferred.
c. Bundle A has more videos than bundle B, but bundle B has more bags of chips
than bundle A. The “more is better” principle does not help us rank these two
bundles. Without more information, they cannot be ranked.
d. Since we know that you are indifferent between bundle A and bundle B, we know
that they lie on the same indifference curve. Note in the accompanying diagram
that bundle C lies on a straight line between bundles A and B. Since we know that
indifference curves are convex (they get flatter as we move along them to the
right), bundle C has to be on a higher indifference curve than bundle A (and bun-
dle B). Since the number of goods in bundle C is exactly the average of the num-
bers in bundles A and B, sometimes this property of indifference curves is known
as “averages are preferred to extremes.”

Quantity of
breakfasts
A
10

C
7

B
4 I

0 4 7 10
Quantity of dinners

3. a. These indifference curves cross. One of the properties of indifference curve is that
they never cross. This rules out indifference curves like these.
b. This indifference curve does not get flatter as you move along it to the right;
instead, it gets steeper. The property that indifference curves for ordinary goods get
flatter as you move to the right is a result of the assumption of diminishing mar-
ginal utility. So diminishing marginal utility rules out indifference curves like this.
c. This indifference curve satisfies all four properties of indifference curves for ordi-
nary goods.
d. This curve has an upward sloping segment. But such a curve is ruled out by the
principle that more is better. On this indifference curve, there are at least two bun-
dles that have the same amount of good Y, but one has more of good X than the
other. As more is better, these two bundles can’t be valued the same; the one with
more of good X must have higher value than the one with less. Hence they cannot
be on the same indifference curve.
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CHAPTER 11 CONSUMER PREFERENCES AND CONSUMER CHOICE 97

4. First of all, the relative price of CDs in terms of cups of hot chocolate is (Price of
CDs)/(Price of hot chocolate) = $10/$2 = 5. That is, to get 1 more CD, Kory has to give
up 5 cups of hot chocolate.
a. This bundle lies on Kory’s budget line; that is, it is a bundle at which she spends
all her income. Kory’s marginal rate of substitution is less than the relative price
of CDs. She is only willing to exchange 1 cup of hot chocolate for 1 CD. However,
the relative price of 1 CD is 5 cups of hot chocolate; that is, she would have to
give up 5 cups of hot chocolate for 1 CD. Kory values CDs less than they cost her,
so she should consume fewer CDs and, therefore, more hot chocolate to remain
on her budget line. Kory should shift consumption towards hot chocolate until
her MRS is the same as the relative price of CDs.
b. This bundle lies on Kory’s budget line; that is, it is a bundle at which she spends
all her income. Kory’s marginal rate of substitution is MUCD/MUhot chocolate = 25/5 =
5. That is, she is willing to exchange 5 cups of hot chocolate for 1 CD. And the
relative price of 1 CD is 5 cups of hot chocolate, so Kory values CDs equally as
much as they cost her. So this is her optimal consumption bundle.
c. At this bundle, the marginal rate of substitution is equal to the relative price, but
the bundle does not lie on Kory’s budget line: she spends only $30 on it. If her
income were $30, this would be her optimal consumption bundle. However, her
income is $50. And at this higher income she will buy more of both goods, since
both are normal goods for her.

5. a. Raul’s marginal rate of substitution is 1: he is just willing to trade 1 Nolan Ryan

for 1 more Cal Ripken card.
b. Raul’s marginal rate of substitution is MUCal/MUNolan = 1. However, the relative
price of a Cal Ripken card is PCal/PNolan = $24/$12 = 2. Since the marginal rate of
substitution is less than the relative price, Raul can make himself better off by
selling one Cal Ripken card and buying Nolan Ryan cards.
c. If Raul can no longer benefit from trade, he must be consuming his optimal con-
sumption bundle. That is, his marginal rate of substitution must be equal to the
relative price. The relative price rule—which says that MUCal/MUNolan =
PCal/PNolan—applies. Since we know that the relative price is 2, Raul’s marginal rate
of substitution must also be 2.

6. a. Lauren is right. Since Ralph values one more meal twice as much as he values one
more session at the gym, his marginal utility for meals is twice as much as his
marginal utility for gym sessions. That is, his marginal rate of substitution of
meals in place of gym sessions is MUmeal/MUgym = 2. However, the relative price of
a meal is Pmeal/Pgym = 1 (they both cost the same). A in the accompanying diagram
illustrates this bundle. Since his marginal rate of substitution is different from the
relative price, this cannot be his optimal consumption bundle.

Quantity
of gym Optimal
sessions bundle Slope:
A –MUmeal /MUgym = –2
B
I2 Slope:
I1 –Pmeal /Pgym = –1
BL
Quantity of restaurant meals

b. Since Ralph’s marginal rate of substitution is greater than the relative price of a
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98 CHAPTER 11 CONSUMER PREFERENCES AND CONSUMER CHOICE

meal, he should consume more meals (and fewer gym visits) to make himself bet-
ter off. In the diagram, bundle B is the bundle that is optimal: the relative price is
equal to Ralph’s marginal rate of substitution.

7. a. If Sabine can’t tell the difference between Coke and Pepsi, the two are perfect sub-
stitutes for her. She is always willing to exchange 1 six-pack of Pepsi for 1 six-pack
of Coke, so her marginal rate of substitution of Coke in place of Pepsi is 1.
b. Sabine’s indifference curves are the lines labeled I1, I2, and I3 in the accompanying
diagram.
c. Sabine’s budget line is the line labeled BL in the diagram.
d. Sabine’s optimal consumption bundle is bundle A in the diagram: she can get
onto her highest indifference curve by consuming only Pepsi. (In this special case
of perfect substitutes, the relative price rule does not hold. Sabine’s marginal rate
of substitution is less than the relative price, so she should want to consume less
Coke and more Pepsi. But that is impossible since she is already consuming no
Coke!)
e. If the price of Pepsi and Coke is the same, then the budget line has the same slope
as Sabine’s indifference curves. That is, at any bundle on the budget line, the rela-
tive price rule is true! In that case, we cannot predict what Sabine will do: any
bundle on her budget line would be an optimal choice.

Quantity
of Pepsi
A
6

BL
I1 I2 I3
0 2 4 6
Quantity of Coke

8. a. In the accompanying diagram, BL1 is Norma’s original budget line and A is her
optimal consumption bundle. After the increase in the price of nachos, BL2 is her
new consumption bundle and C is her new budget line. The movement from A to
B isolates the pure substitution effect of the rise in the relative price of nachos: at
B she consumes fewer nachos and more salsa. The movement from B to C isolates
the income effect: she has been made poorer by the rise in the price of nachos, so
she consumes fewer nachos at C than at B. Since nachos are a normal good, and
the income and substitution effect run in the same direction when the price
changes for a normal good, one can say definitively that her consumption of
nachos falls in response to the increase in the price of nachos.
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CHAPTER 11 CONSUMER PREFERENCES AND CONSUMER CHOICE 99

Quantity
of salsa

A
C
BLS I2
BL2 I1 BL1
Quantity of nachos

b. We cannot say definitively whether Norma’s consumption of salsa rises or falls. In

the figure above, Norma’s consumption of salsa rises in response to the increase
in the price of nachos: she consumes more salsa at bundle C than she did at bun-
dle A. Depending upon her preferences, however, it is possible that her consump-
tion of salsa falls as well. This will occur if the size of the income effect on salsa
consumption from the price increase of nachos (which makes her poorer) is large
enough to dominate the size of the substitution effect on salsa consumption
(which makes her want to consume more salsa and less nachos). The diagram
below shows a case in which her consumptiion of salsa falls in response to an
increase in the price of nachos. At her new consumption bundle D, she consumes
fewer nachos and less salsa than she did at A.

Quantity
of salsa

A
D I2

BL2 I1 BL1
Quantity of nachos

9. a. Tyrone’s initial optimal bundle of 16 meals and 10 notepads is given by point A,

the point at which I1 and BL1 are tangent. BL1 is found by calculating its horizon-
tal intercept (the quantity of cafeteria meals he can buy if he spends all his
income on meals, equal to $100/$5 = 20) and its vertical intercept (the quantity
of notebooks he can buy if he spends all his income on notebooks, equal to
$100/$2 = 50).

Quantity of
notepads BL
H
100
90

BL2

50
B
BL1
I1
10 I2
A
0 16 18 20
Quantity of cafeteria meals
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100 CHAPTER 11 CONSUMER PREFERENCES AND CONSUMER CHOICE

b. Given the price of notepads falls to $1 while the price of meals stays unchanged
at $5, Tyrone’s budget line, BLH, is given by its vertical intercept ($100/$1 = 100)
and its horizontal intercept ($100/$5 = 20).
c. Given that the price of notepads drops to $1 while the price of meals stays
unchanged at $5, and his income drops to $90, Tyrone’s budget line is BL2. It is
given by its vertical intercept ($90/$1 = 90) and its horizontal intercept ($90/$5
= $18). Note that Tyrone can indeed buy his original consumption bundle of 16
meals and 10 notepads at the new prices and lower income: (16 × $5) + (10 × $1)
= $90. So he cannot be any worse off than he was originally. But, in fact, he is
better off: as can be seen from the diagram, BL2 allows him to reach a higher
indifference curve, I2, than he achieved before.
d. Despite having a lower income ($90 instead of $100), Tyrone is better off because
the fall in the price of notepads has made him richer in a real sense. The fall in
the price of notepads has been sufficiently large so that once he re-allocates his
consumption toward more notepads and fewer meals, he is more than compensat-
ed for the fall in his income level.

10. Gus will buy less gas. The increase in the price of gas makes his budget line steeper (the
relative price of gas is now higher). The increase in income shifts his budget line outward
so that it is just tangent to the indifference curve that he was on before the gas price rose.
That is, Gus goes from bundle A on his original budget line BL1 to bundle B on his new
budget line BL2. In effect, what this policy does is to isolate just the substitution effect of
the price change: the income effect is fully compensated for by the increase in Gus’s
income, so only the substitution effect remains.

Quantity
of food

A
I
BL2 BL1
Quantity of gas

11. a. BL1 in the accompanying diagram is Pam’s budget line. Bundle A, her optimal
choice, lies on indifference curve I1, which slopes downward, has the characteristic
convex shape, and does not cross any other indifference curves.
b. BL2 in the diagram is Pam’s new budget line when Spam costs $1. Bundle C on
indifference curve I2 is her optimal consumption bundle.
c. Budget line BLS isolates just the substitution effect: Pam is on the same indiffer-
ence curve as she was when she consumed bundle A, but the relative price of
Spam is now lower, so she substitutes Spam in place of bread. It is important that
bundle B contains more Spam than bundle C. Going from bundle B to bundle C
shows the income effect, and it has to result in less Spam consumption: since
Spam is an inferior good, as Pam’s income increases, she will consume less of it.
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CHAPTER 11 CONSUMER PREFERENCES AND CONSUMER CHOICE 101

Quantity
of bread

10
C
7
6 A I2
B
I1
BL1 BLS BL2
0 4 6 10 20
Quantity of Spam

12. a. BL1 in the accompanying diagram shows Katya’s budget line, and the optimal con-
sumption bundle is labeled A.
b. Katya’s budget line after the price of public transport has fallen is labeled BL2 in
the diagram.
c. Katya’s optimal consumption bundle is C. Since public transport is not a Giffen
good, we know that as a result of the price fall, Katya’s consumption of public
transport will increase. (Only if it were a Giffen good would consumption of a
good fall as its price falls.)
d. The BLS in the diagram isolates the substitution effect. The move from bundle A to
bundle B shows the substitution effect. It tells you that Katya will substitute more
public transport in place of fewer car rides since the relative price of public trans-
port has fallen. The move from bundle B to bundle C shows the income effect.
Since public transport is an inferior good, the income effect tells you that Katya
will consume less public transport as her income rises. For inferior goods, the
income and substitution effects work in opposite directions.

Quantity
of car
travel
C
A
I2

BL1 BLS I1 BL2

Quantity of public transport

13. a. Bundle A in the accompanying diagram is Crandall’s optimal consumption bun-

dle. When cheese cubes cost 20 cents and crackers cost 10 cents, his budget line is
BL1. He consumes 8 cheese cubes and 8 crackers.
b. When the price of crackers rises to 20 cents, Crandall’s budget line becomes BL2
in the diagram, and his optimal consumption bundle is B. He consumes 6 cheese
cubes and 6 crackers.
c. To isolate the substitution effect of this price rise, we run through the following
thought experiment: Give Crandall just enough extra income to bring him onto
the same indifference curve that he was on before the price rise. The budget line
that does this is BLS in the diagram, and in that case, Crandall would consume
the same bundle that he consumed to begin with (bundle A). So in this special
case there is no substitution effect. The move from bundle A to bundle B is entire-
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102 CHAPTER 11 CONSUMER PREFERENCES AND CONSUMER CHOICE

ly accounted for by the income effect. Of course this is intuitive: since the two
goods are perfect complements, they are not substitutable—and so it makes sense
that there is no substitution effect.

Quantity of
cheese cubes
16
14
12
10
A
8 I2
6 I1
B
4
2 BL2 BLS BL1

0 2 4 6 8 10 12 14 16 18 20 22 24 26
Quantity of crackers

14. a. Carmen’s budget line when she has $50 to spend is BL1 in the accompanying dia-
gram. Her optimal consumption bundle is A, lying on indifference curve I1.
b. Carmen’s budget line when she has $100 to spend is BL2 in the diagram. Her opti-
mal consumption bundle is bundle B, lying on indifference curve I2. Since cafete-
ria meals are an inferior good, this increase in income must reduce Carmen’s con-
sumption of cafeteria meals. This increase in income causes a pure income effect,
and for inferior goods the income effect of an increase in income is to reduce
consumption.
c. It is not possible to draw an indifference curve for which all goods are inferior
goods. This is because as your income increases, you have more money to spend,
and you will always spend all your money (because of the “more is better”
assumption). If, as a result of this income increase, you buy less of one good (an
inferior good), you must spend more on the other—making the other good a nor-
mal good.

Quantity
of CDs
10
B
I2
5
BL1 A
I1 BL2
0 10 20
Quantity of cafeteria meals