Chapter 6
Achieving the Optimum in Spite of Constraints
In This Chapter
Breaking down the effect of a change in prices into income and substitution effects
How consumers’ preferences are revealed
Comparing income and substitution effects
The single most important part of microeconomics is the constrained optimization model, which is based on the idea that people act to achieve the best they can, given some kind of constraint that limits their choice. This way of looking at people’s decisions runs through most of the microeconomic syllabus, finding its way into all sorts of things from consumer choice to environmental or health economics. Yet its roots lie in the way economists look at individual decision-making.
To microeconomists, people optimize. When prices change, people respond to the information and react. Suppose you have $1 in your pocket to spend on a treat. You have two types of available treats, chocolate bars and cookies, and you start by getting your best mix of the two: that’s two of each to begin with. Now imagine that the price of cookies goes up. What do you do? Well, if you’re behaving as microeconomists suggest, you switch some of your consumption from cookies ...
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