Consumer Choice

Source: Chapter # 04, Microeconomics,

Fourth Edition by David Besanko &
Ronald R. Braeutigam
 THE BUDGET CONSTRAINT
• The set of baskets that a consumer can
purchase with a limited amount of income

• Budget Line: The set of baskets that a

consumer can purchase when spending all of
his or her available income.
Budge Set For Two Goods
 Slope of Budge Line
• The slope of the budget line tells us how
many units of the good on the vertical axis a
consumer must give up to obtain an additional
unit of the good on the horizontal axis.

• That the slope of the budget line is ( The

relative prices)
• Economic rate of substitution
HOW DOES A CHANGE IN INCOME
AFFECT THE BUDGET LINE?
HOW DOES A CHANGE IN PRICE
AFFECT THE BUDGET LINE?
 OPTIMAL CHOICE
• A rational consumer chooses a basket of
goods that
(1) maximizes his satisfaction (utility)
(2) allows him to live within his budget
constraint
The Problem of Optimal Consumer Choice

• Assumption: At an optimal basket all income

will be spent, the BL becomes

• Objective function:

• Decision variables:
Optimal Choice
 Consumer Equilibrium Condition
• The slope of the budget line and the
slope of the indifference ( )curve
are equal:
• OR

• Interior Optimum: An optimal basket at which

a consumer will be purchasing positive
amounts of all commodities.
 TWO WAYS OF THINKING ABOUT OPTIMALITY

• Utility maximization

• Expenditure minimization
Expenditure Minimization Problem
• Consumer choice between goods that will minimize
total spending while achieving a given level of utility
 Corner Solution
• A solution to the consumer’s optimal choice problem
at which some good is not being consumed at all, in
which case the optimal basket lies on an axis
Corner Solution in Case Perfect Substitutes
APPLICATION: JOINING A CLUB
APPLICATION: QUANTITY DISCOUNTS