| 9 |possibilites, preferences, | | |and choices |
Answers to the Review Quizzes
What does a household’s budget line show?
The budget line plots combinations of goods that require all a household’s income and describes the limits to its consumption choices. 2.
How does the relative price and a household’s real income influence its budget line? The magnitude of the slope of the budget line equals the relative price of the good or service measured on the horizontal axis. A fall in the price of the good measured on the horizontal (vertical) axis decreases that good’s relative price and decreases (increases) the slope of the budget line. A household’s real income is the household’s income expressed as a quantity of goods the household can afford to buy. An increase (decrease) in household income causes a parallel shift of the budget line rightward (leftward). The slope of the budget line does not change when income changes. 3.
If a household has an income of $40 and buys only bus rides at $2 each and magazines at $4 each, what is the equation of the household’s budget line? The budget equation states that a consumer’s spending must equal his or her income. The budget equation is derived for two goods, bus rides and magazines. The amount spent on bus rides is (Pbus ride)(Qbus ride), the amount spent on magazines is (Pmagazine)(Qmagazine), and the consumer’s income is y. We know that (Pmagazine)(Qmagazine) + (Pbus ride)(Qbus ride) = y. Rearrange this equality by subtracting the amount spent on bus rides from both sides to give (Pmagazine)(Qmagazine) = y – (Pbus ride)(Qbus ride). Finally, divide both sides by the price of magazine to give the budget equation Qmagazine = y/Pmagazine – (Pbus ride /Pmagazine)(Qbus ride). Substituting in our values, y = $40, P bus ride = $2 and P magazine = $4, gives Qmagazine = $40/$4 – ($2/$4)(Qbus ride) which is equal to Qmagazine = 10 – 0.5 Qbus ride 4.
If the price of one good changes, what happens to the relative price and the slope of the household’s budget line? A relative price is the price of one good divided by the price of another good. For example, the magnitude of the slope of the budget line (Pmovie/Psoda) is the relative price of a movie in terms of soda. This relative price shows how many sodas must be forgone to see an additional movie. A fall in the price of the good on the horizontal (vertical) axis increases the total affordable quantity of that good, decreases its relative price, and decreases (increases) the magnitude of the slope of the budget line. 5.
If a household’s money income changes and prices do not change, what happens to the household’s real income and budget line? A household’s real income is the household’s income expressed as a quantity of goods the household can afford to buy. For example, the vertical intercept for a budget line measuring soda on the vertical axis is (y/Psoda), which is the consumer’s real income in terms of sodas. A change in a household’s money income changes the household’s real income in terms of both goods and causes a parallel shift of the budget line. If a household’s money income increases, its budget line shifts rightward and if a household’s money income decreases, it budget line shifts leftward.
What is an indifference curve and how does a preference map show preferences? An indifference curve shows those combinations of goods for which a consumer is indifferent. The consumer has the same level of satisfaction for any combination on a given indifference curve. The family of indifference curves is the preference map. This map shows the person’s preferences because it shows how the person ranks each combination of goods. 2.
Why does an indifference curve slope downward and why is it bowed toward the origin? The downward...
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