Consumer’s Choices Let’s now use this model of consumer choice to consider how a change in the
price of one of the goods alters the consumer’s choices. Suppose, in particular,
that the price of Pepsi falls from $2 to $1 per liter. It is no surprise that the lower
price expands the consumer’s set of buying opportunities. In other words, a fall in
the price of any good shifts the budget constraint outward.
Figure 9 considers more specifically how the fall in price affects the budget con-
straint. If the consumer spends her entire $1,000 income on pizza, then the price of
Pepsi is irrelevant. Thus, point A in the figure stays the same. Yet if the consumer
spends her entire income of $1,000 on Pepsi, she can now buy 1,000 rather than
only 500 liters. Thus, the end point of the budget constraint moves from point B
to point D.
Notice that in this case the outward shift in the budget constraint changes
its slope. (This differs from what happened previously when prices stayed the
same but the consumer’s income changed.) As we have discussed, the slope of
the budget constraint reflects the relative price of pizza and Pepsi. Because the
price of Pepsi has fallen to $1 from $2, while the price of pizza has remained $10,
the consumer can now trade a pizza for 10 rather than 5 liters of Pepsi. As a result,
the new budget constraint has a steeper slope.
How such a change in the budget constraint alters the consumption of both
goods depends on the consumer’s preferences. For the indifference curves drawn
in this figure, the consumer buys more Pepsi and less pizza.
FIGURE 8 An Inferior Good a good is inferior if the
consumer buys less of it
when her income rises. Here
Pepsi is an inferior good:
When the consumer’s income
increases and the budget
constraint shifts outward,
the consumer buys more
pizza but less Pepsi.