This chapter analyzes consumer decisions. Your choice among different consumption bundles, if you are rational, will depend upon your preferences (what you want to do) and your opportunities (what you are able to do). And, in a market economy, opportunities will in turn depend upon your income and upon the prices you face. Individual consumption choices respond to all three of these variables: preferences, incomes, and market prices.
THE OPTIMUM OF THE CONSUMER
The Geometry of Consumer Choice
Dealing for simplicity with only two goods, Figure 4.1 shows the baskets of goods X and Y that a consumer with a given income can afford (the shaded triangle). The upper boundary of the shaded area, the budget line KL, shows the baskets attainable by a person who spends all of his or her income on the two goods X and Y.
Suppose that Mary's income is I = $100 and that the market prices are Px = $2 and Py = $1. Spending all of her income on X, Mary could buy x = 100/2 = 50 units. This would put her at point L in the diagram. At the other extreme she could buy y = 100/1 = 100 units of good Y (point K). More generally she could afford any combination of X and Y lying on her budget line – the straight line between points K and L.