FMSC 290 Chapter Notes - Chapter 3: Budget Constraint, Indifference Curve, Comparative Advantage
1 May 2018
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Notes for Chapter 3 Mankiw Microeconomics
• The Neoclassical model of specialization and exchange
o Basic underlying assumption
▪ The family is a unit whose adult members make informed and rational
decisions that maximize the well-being of the family
o Family well-being or utility is maximized by having a combination of commodities
from which the family derives the greatest satisfaction
o Commodities- produced by combining home time of family members with goods
and services purchased in the market using labor market earnings
• Law of comparative advantage
o The total output of a group, an economy, a group of nations or a family will be
greatest when output of each good is produced by the person with the lowest
opportunity cost
• Indifference curve
o A curve that shows the consumption alternatives that yield the same level of
satisfaction or utility
o In other words, a couple is indifferent between the points on the indifference curve
o Utility is greatest for curves that are higher and further to the right
o Indifference curves are downward slopping
• Family budget constraint
o A family has limited income
o There is a limit on the consumption bundles a family can afford
▪ This will require a trade-off
o Slope of the budget constraint: rate at which the family (or consumer) can trade one
good for another
• Indifference curve
o Shows the consumption bundles that gives the family or consumer the same level
of satisfaction/utility
o Combinations of goods on the same curve
o Slope of indifferent curve: MRS, marginal rate of substitution
o Rate at which family or consumer is willing to trade one good for another
• Preferences/examples of indifference curves
o Perfect substitutes (linear indifference curve)
▪ Two goods with straight-line indifference curves
▪ Marginal rate of substitution- constant
o Perfect compliments (right angle)
▪ Two goods with right-angle indifference curves
• Optimization
o Optimum
▪ Point where indifference curve and budget constraint touch
▪ Best combination of goods available to the consumer
• Occam’s razor: if there are two explanations for something, the simpler one is usually the
better one
• Economists may disagree
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