ECON 101:

Introduction to
Microeconomics
Lesson 23
Chapter 21: The Theory of Consumer Choice

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Rationale
• Once the framework of consumption possibilities frontiers and
individual preferences have been developed, it will be used to
understand changes in consumption behavior when individual
income and prices of products change. This will illustrate one
aspect of how consumers may make decisions when given
choices.

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Objectives
By the end of this lesson, students will be able to answer the
following questions:
• How does the budget constraint represent the choices a
consumer can afford?
• How do indifference curves represent the consumer’s
preferences?
• What determines how a consumer divides her resources
between two goods?

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Prior Knowledge
An understanding of:
• What determines demand and supply in a competitive market
• How the production possibilities frontier depicts trade-offs and
opportunity costs

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Introduction
• Recall one of the Ten Principles:
People face tradeoffs.
– Buying more of one good leaves
less income to buy other goods.
– Working more hours means more income and more consumption,
but less leisure time.
– Reducing saving allows more consumption today but reduces future
consumption.
• This chapter explores how consumers make choices like these.

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The Theory of Consumer Choice
• The theory of consumer choice addresses the following questions:
– Do all demand curves slope downward?
– How do wages affect labor supply?
– How do interest rates affect household saving?

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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.

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THE BUDGET CONSTRAINT: WHAT THE
CONSUMER CAN AFFORD
• 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.

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ACTIVE LEARNING 1: Budget Constraint
Sandra’s income: $1000
Prices: $10 per pizza, $2 per pint of Pepsi
A. If Sandra spends all her income on pizza, how many pizzas does
she buy?
B. If Sandra spends all her income on Pepsi, how many pints of Pepsi
does she buy?
C. If Sandra spends $400 on pizza, how many pizzas and Pepsis does
she buy?
D. Plot each of the bundles from parts A-C on a diagram that measures
the quantity of pizza on the horizontal axis and quantity of Pepsi on
the vertical axis, then connect the dots.
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Short Answer: Budget Constraint
Sandra’s income is $1000. The price of a pizza is $10 and the price
of a pint of Pepsi is $2.

If Sandra spends all her income on pizza, how many pizzas does
she buy?

Type your response.

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Short Answer: Budget Constraint
Sandra’s income is $1000. The price of a pizza is $10 and the price
of a pint of Pepsi is $2.

If Sandra spends all her income on Pepsi, how many pints of Pepsi
does she buy?

Type your response.

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© Cengage Learning
Short Answer: Budget Constraint
Sandra’s income is $1000. The price of a pizza is $10 and the price
of a pint of Pepsi is $2.

If Sandra spends $400 on pizza, how many pizzas and Pepsis does
she buy?

Type your response.

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Whiteboard: Budget Constraint

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THE BUDGET CONSTRAINT: WHAT THE
CONSUMER CAN AFFORD
• 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.

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The Slope of the Budget Constraint
Pepsi
From C to D,
“rise” = –100 Pepsis 500

“run” = +20 pizzas 400

Slope = –5 C
300
D
200
Consumer must give up 5
Pepsis to get another pizza.
100

0
0 20 40 60 80 100 Pizza
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The Slope of the Budget Constraint

• The slope of the budget constraint equals

• the rate at which the consumer
can trade Pepsi for pizza
• the opportunity cost of pizza in terms of Pepsi
• the relative price of pizza:

Price of pizza $10

= = 5 Pepsis per pizza
Price of Pepsi $2

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ACTIVE LEARNING 2: Budget Constraint
Pepsi

Show what happens to the 500

budget constraint if:
400
A. Income falls to $800
B. The price of Pepsi rises 300
to $4/pint.
200

100

0
0 20 40 60 80 100 Pizza
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Short Answer: Budget Constraint (2A)
Sandra’s income is $800. The price of a pizza is $10 and the price
of a pint of Pepsi is $2.

If Sandra spends all her income on pizza, how many pizzas does
she buy?

If Sandra spends all her income on Pepsi, how many Pepsis does
she buy?

Type your response.

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Whiteboard: Budget Constraint (2A)

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Short Answer: Budget Constraint (2B)
Sandra’s income is $1000. The price of a pizza is $10 but the price
of a pint of Pepsi has risen to $4.

If Sandra spends all her income on pizza, how many pizzas does
she buy?

If Sandra spends all her income on Pepsi, how many Pepsis does
she buy?

Type your response.

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Whiteboard: Budget Constraint (2B)

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PREFERENCES: WHAT THE CONSUMER
WANTS
• A consumer’s preference among consumption bundles may
be illustrated with indifference curves.

• An indifference curve is a curve that shows consumption

bundles that give the consumer the same level of satisfaction.

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Figure 2: The Consumer’s Preferences
Quantity Indifference curve:
of Pepsi shows consumption bundles
C that give the consumer the
same level of satisfaction

Indifference
A
curve, I1
0 Quantity
of Pizza 23
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Representing Preferences with Indifference
Curves
• 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.
• …while keeping the level of satisfaction the same

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Figure 2: The Consumer’s Preferences
Quantity Indifference curve:
of Pepsi shows consumption bundles
C that give the consumer the
same level of satisfaction

Indifference
A
curve, I1
0 Quantity
of Pizza 25
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Four Properties of Indifference Curves
• Higher indifference curves are preferred to lower ones.
• Indifference curves are downward sloping.
• Indifference curves do not cross.
• Indifference curves are bowed inward.

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Four Properties of Indifference Curves
• Property 1: Higher indifference curves are preferred to lower
ones.
• Consumers usually prefer more of something to less of it.
• Higher indifference curves represent larger quantities of goods
than do lower indifference curves.

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Figure 2: The Consumer’s Preferences
Quantity
of Pepsi
1. Higher indifference curves
are preferred to lower ones.
C

B D
I2
Indifference
A
curve, I1
0 Quantity
of Pizza 28
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Four Properties of Indifference Curves
• Property 2: Indifference curves are downward sloping.
• A consumer is willing to give up one good only if he or she gets
more of the other good in order to remain equally happy.
• If the quantity of one good is reduced, the quantity of the other
good must increase.
• For this reason, most indifference curves slope downward.
• Remember, a consumer is equally happy at all points along a
given indifference curve.

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Figure 2: The Consumer’s Preferences
Quantity
of Pepsi 2. Indifference curves are
downward sloping.

Indifference
curve, I1
0 Quantity
of Pizza 30
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Four Properties of Indifference Curves
• Property 3: Indifference curves do not cross.
• Points A and B should make the consumer equally happy.
• Points B and C should make the consumer equally happy.
• This implies that A and C would make the consumer equally
happy.
• But C has more of both goods compared to A.

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Figure 2: The Consumer’s Preferences
Quantity
of Pepsi 2. Indifference curves are
downward sloping.

Indifference
curve, I1
0 Quantity
of Pizza 32
© Cengage Learning
Four Properties of Indifference Curves
• Property 4: Indifference curves are bowed inward.
• People are more willing to trade away goods that they have in
abundance and less willing to trade away goods of which they
have little.
• These differences in a consumer’s marginal substitution rates
cause his or her indifference curve to bow inward.

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Figure 4: Bowed Indifference Curves
Quantity
of Pepsi 4. Indifference curves are bowed inward.

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The less pizza the consumer has, the
more Pepsi he is willing to
MRS = 6
trade for another pizza.
A
8
1

4 B
MRS = 1
3
1
Indifference
curve

0 2 3 6 7 Quantity
of Pizza 34
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Two Extreme Examples of Indifference
Curves
• Perfect substitutes
• Perfect complements

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Two Extreme Examples of Indifference
Curves
• Perfect Substitutes
• Two goods with straight-line indifference curves are perfect
substitutes.
• The marginal rate of substitution is a fixed number.

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Figure 5: Perfect Substitutes and Perfect
Complements (a) Perfect Substitutes:
Two goods with straight-line indifference curves, constant MRS
Nickels
Example: nickels & dimes
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Consumer is always willing to
trade two nickels for one dime.
4

I1 I2 I3
0 1 2 3 Dimes 37
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Two Extreme Examples of Indifference
Curves
• Perfect Complements
• Two goods with right-angle indifference curves are perfect
complements.
• Since these goods are always used together, extra units of one
good, outside the desired consumption ratio, add no additional
satisfaction.

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Figure 5: Perfect Substitutes and Perfect
Complements (b) Perfect Complements:
Two goods with right-angle indifference curves
Left
Shoes
Example: left shoes, right shoes
{7 left shoes, 5 right shoes}
is just as good as
{5 left shoes, 5 right shoes}

I2
7

5 I1

0 5 7 Right Shoes 39
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Less Extreme Cases: Close Substitutes and
Close Complements
Quantity Indifference Quantity Indifference
of Pepsi curves for close of hot curves for
dog buns close
substitutes are
not very bowed complements
are very
bowed

Quantity Quantity
of Coke of hot dogs 40
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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.
• Combining the indifference curve and the budget constraint
determines the consumer’s optimal choice.

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The Consumer’s Optimal Choice
• Consumer optimum occurs at the point where the highest
indifference curve and the budget constraint are tangent.
• At the consumer’s optimum, the consumer’s valuation of the two
goods equals the market’s valuation.

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Figure 6: The Consumer’s Optimum
Quantity
of Pepsi The consumer would prefer to
be on indifference curve I3, but
does not have enough income
to reach that indifference curve.
Optimum
The consumer can afford
most of the bundles on I1,
B A but why stay there when
you can move out to a
higher indifference curve,
I3 I2 ?
I2
I1

Budget constraint
0 Quantity
of Pizza 43
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Figure 6: The Consumer’s Optimum
Quantity
MRS = Relative Price
of Pepsi
at the optimum:
The indifference curve
and budget constraint
Optimum have the same slope.

B A

I3
I2
I1

Budget constraint
0 Quantity
of Pizza 44
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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.

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Figure 7: An Increase in Income
Quantity
of Pepsi New budget constraint

1. An increase in income shifts the

budget constraint outward . . .

New optimum

3. . . . and
Pepsi
consumption. Initial
optimum I2

Initial
budget
I1
constraint

0 Quantity
of Pizza
2. . . . raising pizza consumption . . .
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How Changes in Income Affect the
Consumer’s Choices
• Normal versus Inferior Goods
• If a consumer buys more of a good when his or her income rises,
the good is called a normal good.
• If a consumer buys less of a good when his or her income rises,
the good is called an inferior good.

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ACTIVE LEARNING 3: Inferior vs.
Normal Goods

• An increase in income increases the quantity demanded of

normal goods and reduces the quantity demanded of inferior
goods.
• Suppose pizza is a normal good but Pepsi is an inferior good.
• Use a diagram to show the effects of an increase in income on
the consumer’s optimal bundle of pizza and Pepsi.

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Whiteboard: Inferior vs. Normal Goods

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1-MINUTE RESPONSE

What was the most important thing you learned today

and what did you understand the least?
Respond in the online classroom.

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Summary of this Lesson
• A consumer’s budget constraint shows the possible
combinations of different goods he can buy given his income and
the prices of the goods.
• The slope of the budget constraint equals the relative price of the
goods.
• The consumer’s indifference curves represent his preferences.
• Points on higher indifference curves are preferred to points on
lower indifference curves.
• The slope of an indifference curve at any point is the consumer’s
marginal rate of substitution.
• The consumer optimizes by choosing the point on his budget
constraint that lies on the highest indifference curve.

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Post-work for Lesson 23
• After the Live Lecture, please review your notes and reflect on
the lesson content. Then, go to the online classroom for details
about the required resources.

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To Prepare for the Next Lesson
• Complete the post-work for Lesson 23
• Complete the pre-work for Lesson 24
• Read the required readings for Lesson 24

Go to the online classroom for details.

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