8.1 The options of the consumer

Consumption bundles with budget depletion
Quantity Good 1 Quantity Good 2 Expenditures
Good 1 (in Euros)
Good 2 (in Euro)
Total expenditures (in Euro)

In the following section the theory of consumer decision will be presented. For this purpose, we assume a representative household that spends its income entirely on the consumption of only two goods. This simplifying assumption allows a more detailed analysis of the theoretical processes behind the consumer’s behavior. In our example these two goods are called Good 1 and Good 2 . Of course, the household cannot consume an unlimited amount of these two goods, because its expenditure is limited by its disposable income. In the above graph, we can vary the income earned by the household and the prices for Good 1 and Good 2 , and observe how this affects different possible combinations of Good 1 and Good 2 . Columns 4 and 5 of the table show how the household divides its income proportionally between the consumption of Good 2 or Good 1 . For example, in row C, 800 of the income is spent on the consumption of Good 1 and 200 of the income on the consumption of Good 2 . The total expenditure always adds up to 100% of the income (1000 at the beginning). Columns 2 and 3 show the amount of each good the consumer gets for the allocated income. This amount depends on the price of the goods. In the case of consumption bundle A, for example, the consumer decides to spend his entire income only on Good 1 . Here, obviously, the quantity that can be consumed increases with increasing income and decreases with increasing price for Good 1 , but does not change with different prices for Good 2 . The goods combination K works analogously. If, on the other hand, he divides his income between both goods – like in the rows between A and K – the consumed bundle of goods depends on the prices of both goods as well as on the disposable income. Which bundle of goods the consumer chooses in the end will be the subject of analysis on the following pages. Looking at the points A to K in the right-hand coordinate system, it can already be presumed that the possible consumption bundles are all on the same straight line for complete budget consumption.

(c) by Christian Bauer
Prof. Dr. Christian Bauer
Chair of monetary economics
Trier University
D-54296 Trier
Tel.: +49 (0)651/201-2743
E-mail: Bauer@uni-trier.de
URL: https://www.cbauer.de