Chapter Five

Choices by Consumers
 Gains from Exchange

• This graph shows that both

consumers and producers
gain from exchange. Here
the equilibrium market
price is $1 per unit.
• The demand curve shows
the maximum that
consumers would willingly
pay for each unit.
• The supply curve shows
the minimum that
producers would willingly
accept rather than put their
resources to work
elsewhere.
 Gains from Exchange
Q. Why is consumer surplus
measured as the area of the
triangle between the demand
curve and the market price?
A. The demand curve measures the
maximum amount that
consumers would be willing to
pay for each unit sold. Consumer
surplus is a measure of the
difference between the maximum
that consumers would have been
willing to pay and what they
actually pay at the market price.
This is a surplus because the
consumer purchases each unit for
less than what they would
willingly have paid for it.
 Gains from Exchange
Q. Why is producer surplus
measured as the area of the
triangle between the supply
curve and the market price?
A. The height of the supply curve at
any point represents the minimum
that producers would willingly
accept for each unit. The producer
surplus earned on each unit is the
difference between the market
price and the minimum that the
producers would have been willing
to accept in exchange for that unit.
This is a surplus because the
producer sells each unit for more
than they need to offer that unit for
sale.
Appendix to Chapter Five

Indifference Curves
 Indifference Curve
• Economists describe utility as the
pleasure or satisfaction people obtain
from consuming a good or service.
• Each point in this graph stands for a
basket of meat and cheese. A, B, C,
and D are baskets among which a
certain consumer is indifferent.
• All give equal utility. Those points
and all the others on a smooth curve
connecting them form an indifference
set. An indifference curve is a
graphical representation of an
indifference set.
 Indifference Curve
Characteristics of Indifference
Curves:
1. Indifference curves normally have
negative slopes.
2. The absolute value of the slope of an
indifference curve at any point is the
ratio of the marginal utility of the good
on the horizontal axis to the marginal
utility of the good on the vertical axis.
3. Indifference curves are convex; their
slopes decrease as one moves downward
and to the right along them.
4. An indifference curve can be drawn
through the point that represents any
basket of goods.
5. Indifference curves do not cross.
 Indifference Curve
Q. What happens when a consumer
moves from point D to point C on this
indifference curve for meat and
cheese?
A. Between D and C, the slope of the curve
is approximately –2. This shows that the
marginal utility of meat is approximately
twice that of cheese when the amounts
consumed are in the region of baskets C
and D. Because the marginal utility of
meat is twice that of cheese in this
region, the consumer will feel neither a
gain nor a loss in total utility in trading
basket D for basket C, that is, in giving
up two pounds of cheese for one extra
pound of meat.
 Budget Line
• The range of choices open to a
consumer with a given budget and
with given prices can be shown on
the same kind of graph we have
used for indifference curves.

• Such a line is called a budget line.

 Budget Line
Q. Suppose you have a food budget of
$10 per week, the price of meat is $2
a pound, and the price of cheese is $1
a pound. According to this budget
line, if you buy two pounds of meat,
how much cheese will you buy?
A. Six pounds of cheese.

Q. Does this budget line show the

possible combination of buying a
fraction of a pound of meat or
cheese?
A. Yes. The consumption opportunity
line (budget line) shows all the
possible combinations given these
prices and your budget.
 Consumer Equilibrium
• Consumer equilibrium is the
point at which you cannot
increase your utility by
spending less on one good
and more on the other within
a given budget.

• Indifference curves and the

budget line can be used to
give a graphic representation
of consumer equilibrium.
 Consumer Equilibrium

Q. Given the indifference curves

and budget line shown, which
point represents consumer
equilibrium for meat and
cheese?
A. E is the point of consumer
equilibrium. All points that are
better than E (such as F) lie
outside the budget line. All
other points for goods that the
consumer can afford to buy
(such as A and D) lie on lower
indifference curves than E and
hence are less preferred.