MIC
`
`EIGHTH EDITION
`
`[CONOMICS
`
`Robert S. Pindyck
`
`Massachusetts Institute of Technology
`
`Daniel L. Rubinfeld
`
`University of California, Berkeley
`
`PEARSON
`
`Boston Columbus Indianapolis New York San Francisco Upper Saddle River
`Amsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto
`Delhi Mexico City Sio Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo
`
`Exhibit 2245
`Page 01 of 46
`
`

`

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`Library of Congress Cataloging-in-Publication Data
`Pindyck, Robert S.
`Microeconomics / Robert S. Pindyck, Daniel L. Rubinfeld. — 8th ed.
`p. cm. — (The Pearson series in economics)
`ISBN-13: 978-0-13-285712-3
`ISBN-10: 0-13-285712-X
`I. Rubinfeld, Daniel L
`1. Microeconomics.
`HB172.P53 2013
`338.5—dc23
`
`1.1. Title.
`
`20111149296
`
`10 9 8 7 6 5 4 3 2 1
`
`PEARSON
`
`0-13-285712-X
`ISBN 10:
`ISBN 13: 978-0-13-285712-3
`
`Exhibit 2245
`Page 02 of 46
`
`

`

`BRIEF CONTENTS
`
`o PART ONE
`Introduction: Markets and Prices 1
`Preliminaries 3
`2 The Basics of Supply and Demand 21
`
`® PART TWO
`Producers, Consumers, and Competitive Markets 65
`3
`Consumer Behavior 67
`4
`Individual and Market Demand 111
`5 Uncertainty and Consumer Behavior 159
`Production 201
`The Cost of Production 229
`Profit Maximization and Competitive Supply 279
`The Analysis of Competitive Markets 317
`
``7
`8
`
`o PART THREE
`Market Structure and Competitive Strategy 355
`10 Market Power: Monopoly and Monopsony 357
`•
`Pricing with Market Power 399
`12 Monopolistic Competition and Oligopoly 451
`13 Game Theory and Competitive Strategy 487
`14 Markets for Factor Inputs 529
`15
`Investment, Time, and Capital Markets 559
`
`• PART FOUR
`Information, Market Failure, and the Role
`of Government 593
`16 General Equilibrium and Economic Efficiency 595
`17 Markets with Asymmetric Information 631
`18 Externalities and Public Goods 661
`Appendix: The Basics of Regression 700
`Glossary 708
`Answers to Selected Exercises 718
`Photo Credits 731
`Index 732
`
`vii
`
`Exhibit 2245
`Page 03 of 46
`
`

`

`(HAPT
`
`Consumer Behavior
`
`Some time ago, General Mills introduced a new breakfast cereal.
`
`The new brand, Apple-Cinnamon Cheerios, was a sweetened and
`more flavorful variant on General Mills' classic Cheerios product.
`But before Apple-Cinnamon Cheerios could be extensively marketed,
`the company had to resolve an important problem: How high a price
`should it charge? No matter how good the cereal was, its profitabil-
`ity would depend on the company's pricing decision. Knowing that
`consumers would pay more for a new product was not enough. The
`question was how much more. General Mills, therefore, had to conduct a
`careful analysis of consumer preferences to determine the demand for
`Apple-Cinnamon Cheerios.
`General Mills' problem in determining consumer preferences
`mirrors the more complex problem faced by the U.S. Congress in eval-
`uating the federal Food Stamps program. The goal of the program is
`to give low-income households coupons that can be exchanged for
`food. But there has always been a problem in the program's design
`that complicates its assessment: To what extent do food stamps pro-
`vide people with more food, as opposed to simply subsidizing the
`purchase of food that they would have bought anyway? In other
`words, has the program turned out to be little more than an income
`supplement that people spend largely on nonfood items instead of
`a solution to the nutritional problems of the poor? As in the cereal
`example, we need an analysis of consumer behavior. In this case,
`the federal government must determine how spending on food, as
`opposed to spending on other goods, is affected by changing income
`levels and prices.
`Solving these two problems—one involving corporate policy and
`the other public policy—requires an understanding of the theory
`of consumer behavior: the explanation of how consumers allocate
`incomes to the purchase of different goods and services.
`
`Consumer Behavior
`How can a consumer with a limited income decide which goods and
`services to buy? This is a fundamental issue in microeconomics—one
`that we address in this chapter and the next. We will see how con-
`sumers allocate their incomes across goods and explain how these
`allocation decisions determine the demands for various goods and
`
`CHAPTER OUTLINE
`
`Consumer 'references
`69
`
`3.2 Budge:- Constraints
`82
`
`3.3 Consumer Choice
`86
`
`Revealed Preference
`92
`
`3.5 Marginal Utility and Consumer
`Choice
`95
`
`*3.6 Cost-of-Living Indexes
`100
`
`1ST OF EXAMPLES
`
`3.1 Designing New Automobiles (I)
`77
`
`3.2 Can Money Buy Happiness?
`81
`
`3.3 Designing New Automobiles (II)
`88
`
`3.4 Consumer Choice
`of Health Care
`90
`
`3.5 A College Trust Fund
`92
`
`3.6 Revealed Preference
`for Recreation
`94
`
`3.7 Marginal Utility and Happiness
`97
`
`3,S The Bias in the CPI
`105
`
`67
`
`Exhibit 2245
`Page 04 of 46
`
`

`

`S
`tl
`n
`
`t]
`
`t.
`
`i.
`l<
`
`r
`
`68 PART 2 • Producers, Consumers, and Competitive Markets
`
`theory of consumer
`behavior Description of how
`consumers allocate incomes
`among different goods and
`services to maximize their
`well-being.
`
`services. In turn, understanding consumer purchasing decisions will help us to
`understand how changes in income and prices affect the demand for goods and
`services and why the demand for some products is more sensitive than °thee
`to changes in prices and income.
`Consumer behavior is best understood in three distinct steps:
`
`1. Consumer Preferences: The first step is to find a practical way to describe
`the reasons people might prefer one good to another. We will see how a
`consumer's preferences for various goods can be described graphically and
`algebraically.
`2. Budget Constraints: Of course, consumers also consider prices. In Step
`therefore, we take into account the fact that consumers have limiter
`incomes which restrict the quantities of goods they can buy. What doe-
`a consumer do in this situation? We find the answer to this question by
`putting consumer preferences and budget constraints together in the third
`step.
`3. Consumer Choices: Given their preferences and limited incomes, consum-
`ers choose to buy combinations of goods that maximize their satisfactior
`These combinations will depend on the prices of various goods. Thu,
`understanding consumer choice will help us understand demand—i.e
`how the quantity of a good that consumers choose to purchase depends or
`its price.
`
`These three steps are the basics of consumer theory, and we will go through
`them in detail in the first three sections of this chapter. Afterward, we will explore
`a number of other interesting aspects of consumer behavior. For example, we
`will see how one can determine the nature of consumer preferences from actual
`observations of consumer behavior. Thus, if a consumer chooses one good
`over a similarly priced alternative, we can infer that he or she prefers the first
`good. Similar kinds of conclusions can be drawn from the actual decisions tha,
`consumers make in response to changes in the prices of the various goods and
`services that are available for purchase.
`At the end of this chapter, we will return to the discussion of real and nomi
`nal prices that we began in Chapter 1. We saw that the Consumer Price Inde
`can provide one measure of how the well-being of consumers changes ovel
`time. In this chapter, we delve more deeply into the subject of purchasing powe
`by describing a range of indexes that measure changes in purchasing power
`over time. Because they affect the benefits and costs of numerous social-welfare
`programs, these indexes are significant tools in setting government policy in the
`United States.
`
`WHAT DO CONSUMERS DO? Before proceeding, we need to be clear about
`our assumptions regarding consumer behavior, and whether those assump-
`tions are realistic. It is hard to argue with the proposition that consumers
`have preferences among the various goods and services available to them
`and that they face budget constraints which put limits on what they can buy
`But we might take issue with the proposition that consumers decide which
`combinations of goods and services to buy so as to maximize their satisfac-
`tion. Are consumers as rational and informed as economists often make then
`out to he?
`We know that consumers do not always make purchasing decision,
`rationally. Sometimes, for example, they buy on impulse, ignoring or not
`
`Exhibit 2245
`Page 05 of 46
`
`

`

`CHAPTER 3 • Consumer Behavior 69
`
`fully accounting for their budget constraints (and going into debt as a result).
`Sometimes consumers are unsure about their preferences or are swayed by
`the consumption decisions of friends and neighbors, or even by changes in
`mood. And even if consumers do behave rationally, it may not always be fea-
`sible for them to account fully for the multitude of prices and choices that
`they face daily.
`Economists have recently been developing models of consumer behavior
`that incorporate more realistic assumptions about rationality and decision
`making. This area of research, called behavioral economics, has drawn heav-
`ily from findings in psychology and related fields. We will discuss some
`key results from behavioral economics in Chapter 5. At this point we simply
`want to make it clear that our basic model of consumer behavior necessarily
`makes some simplifying assumptions. But we also want to emphasize that
`this model has been extremely successful in explaining much of what we
`actually observe regarding consumer choice and the characteristics of con-
`sumer demand. As a result, this model is a basic "workhorse" of economics.
`It is used widely, not only in economics, but also in related fields such as
`finance and marketing.
`
`3.1 Consumer Preferences
`Given both the vast number of goods and services that our industrial economy
`provides for purchase and the diversity of personal tastes, how can we describe
`consumer preferences in a coherent way? Let's begin by thinking about how a
`consumer might compare different groups of items available for purchase. Will
`one group of items be preferred to another group, or will the consumer be indif-
`ferent between the two groups?
`
`Market Baskets
`We use the term market basket to refer to such a group of items. Specifically, a
`market basket is a list with specific quantities of one or more goods. A mar-
`ket basket might contain the various food items in a grocery cart. It might also
`refer to the quantities of food, clothing, and housing that a consumer buys each
`month. Many economists also use the word bundle to mean the same thing as
`market basket.
`How do consumers select market baskets? How do they decide, for example,
`how much food versus clothing to buy each month? Although selections may
`occasionally be arbitrary, as we will soon see, consumers usually select market
`baskets that make them as well off as possible.
`Table 3.1 shows several market baskets consisting of various amounts of
`food and clothing purchased on a monthly basis. The number of food items
`can be measured in any number of ways: by total number of containers, by
`number of packages of each item (e.g., milk, meat, etc.), or by number of
`pounds or grams. Likewise, clothing can be counted as total number of pieces,
`as number of pieces of each type of clothing, or as total weight or volume.
`Because the method of measurement is largely arbitrary, we will simply
`describe the items in a market basket in terms of the total number of units of
`each commodity. Market basket A, for example, consists of 20 units of food
`and 30 units of clothing, basket B consists of 10 units of food and 50 units of
`clothing, and so on.
`
`S market basket (or bundle)
`List with specific quantities of
`one or more goods.
`
`Exhibit 2245
`Page 06 of 46
`
`

`

`70 PART 2 • Producers, Consumers, and Competitive Markets
`
`A
`
`3
`
`L
`
`ATIVEllAARKETiASKETSH:
`
`MARKET BASKET
`
`UNITS OF FOOD
`
`UNITS OF CLOTHING
`
`A
`B
`
`D
`
`E
`
`G
`
`H
`
`20
`
`10
`
`40
`
`30
`
`10
`
`10
`
`30
`
`50
`
`20
`
`40
`
`20
`
`40
`
`Note: We will avoid the use of the letters C and F to represent market baskets, whenever market baskets might be
`confused with the number of units of food and clothing.
`
`To explain the theory of consumer behavior, we will ask whether consumer-
`prefer one market basket to another. Note that the theory assumes that consumers
`preferences are consistent and make sense. We explain what we mean by thes(
`assumptions in the next subsection.
`
`Some Basic Assumptions about Preferences
`The theory of consumer behavior begins with three basic assumptions about
`people's preferences for one market basket versus another. We believe that these
`assumptions hold for most people in most situations.
`
`1. Completeness: Preferences are assumed to be complete. In other words
`consumers can compare and rank all possible baskets. Thus, for any two
`market baskets A and B, a consumer will prefer A to B, will prefer B to A,
`or will be indifferent between the two. By indifferent we mean that a per-
`son will be equally satisfied with either basket. Note that these preferences
`ignore costs. A consumer might prefer steak to hamburger but buy ham-
`burger because it is cheaper.
`2. Transitivity: Preferences are transitive. Transitivity means that if a consumer
`prefers basket A to basket B and basket B to basket C, then the consume
`also prefers A to C. For example, if a Porsche is preferred to a Cadillac am'
`a Cadillac to a Chevrolet, then a Porsche is also preferred to a Chevrolet
`Transitivity is normally regarded as necessary for consumer consistency
`3. More is better than less: Goods are assumed to be desirable—i.e., to bt
`good. Consequently, consumers always prefer more of any good to less. In adult.
`Lion, consumers are never satisfied or satiated; more is always better, cvc!!
`just a little better.' This assumption is made for pedagogic reasons; name
`ly, it simplifies the graphical analysis. Of course, some goods, such as ai
`pollution, may be undesirable, and consumers will always prefer less. VW
`ignore these "bads" in the context of our immediate discussion of consumer
`choice because most consumers would not choose to purchase them. W.
`will, however, discuss them later in the chapter.
`
`These three assumptions form the basis of consumer theory. They do net
`explain consumer preferences, but they do impose a degree of rationality ant
`reasonableness on them. Building on these assumptions, we will now explore
`consumer behavior in greater detail.
`
`'Thus some economists use the term nonsatiation to refer to this third assumption.
`
`Exhibit 2245
`Page 07 of 46
`
`

`

`CHAPTER 3 • Consumer Behavior 71
`
`0 indifference curve Curve
`representing all combinations
`of market baskets that provide
`a consumer with the same level
`of satisfaction.
`
`Indifference Curves
`We can show a consumer's preferences graphically with the use of indifference
`curves. An indifference curve represents all combinations of market baskets that pro-
`vide a consumer with the same level of satisfaction. That person is therefore indiffer-
`ent among the market baskets represented by the points graphed on the curve.
`Given our three assumptions about preferences, we know that a consumer
`can always indicate either a preference for one market basket over another or
`indifference between the two. We can then use this information to rank all pos-
`sible consumption choices. In order to appreciate this principle in graphic form,
`let's assume that there are only two goods available for consumption: food F
`and clothing C. In this case, all market baskets describe combinations of food
`and clothing that a person might wish to consume. As we have already seen,
`Table 3.1 provides some examples of baskets containing various amounts of
`food and clothing.
`In order to graph a consumer's indifference curve, it helps first to graph his or
`her individual preferences. Figure 3.1 shows the same baskets listed in Table 3.1.
`The horizontal axis measures the number of units of food purchased each week;
`the vertical axis measures the number of units of clothing. Market basket A, with
`20 units of food and 30 units of clothing, is preferred to basket G because A con-
`tains more food and more clothing (recall our third assumption that more is better
`than less). Similarly, market basket E, which contains even more food and even
`more clothing, is preferred to A. In fact, we can easily compare all market baskets
`in the two shaded areas (such as E and G) to A because they contain either more
`or less of both food and clothing. Note, however, that B contains more cloth-
`ing but less food than A. Similarly, D contains more food but less clothing than
`A. Therefore, comparisons of market basket A with baskets B, D, and H are not
`possible without more information about the consumer's ranking.
`This additional information is provided in Figure 3.2, which shows an indiffer-
`ence curve, labeled U,, that passes through points A, B, and D. This curve indi-
`cates that the consumer is indifferent among these three market baskets. It tells
`us that in moving from market basket A to market basket B, the consumer feels
`neither better nor worse off in giving up 10 units of food to obtain 20 additional
`
`Clothing
`(units per week)
`
`50
`
`40
`
`30
`
`20
`
`10
`
`o B
`
`off
`
`G
`
`
`10
`
`FIGURE 3.1
`DESCRIBING INDIVIDUAL PREFERENCES
`Because more of each good is preferred to-
`less, we can compare market baskets in the
`shaded areas. Basket A is clearly preferred
`so basket G, while E is clearly preferred to A.
`However, A cannot be compared with B, D, or
`.H without additional information.
`
`• D
`
`30
`
`40
`
` Food
`(units per week)
`
`Exhibit 2245
`Page 08 of 46
`
`

`

`72 PART 2 • Producers, Consumers, and Competitive Markets
`
`FIGURE 3.2
`AN INDIFFERENCE CURVE
`The indifference curve U, that passes
`through market basket A shows all baskets
`that give the consumer the same level of
`satisfaction as does market basket A; these
`include baskets U and D. Our consumer
`prefers basket E, which lies above U1, to A,
`but prefers A to H or G, which lie below Ul.
`
`Clothing
`(units per week)
`50
`
`
`
`40
`
`30
`
`20
`
`10
`
`-6-
`
`-a
`
`®E
`
`
`
`A
`
`-9-
`
`-2
`
`U
`
`10
`
`20
`
`30
`
`Food
`40
`(units per week)
`
`units of clothing. Likewise, the consumer is indifferent between points A and D:
`He or she will give up 10 units of clothing to obtain 20 more units of food. On the
`other hand, the consumer prefers A to H, which lies below U,.
`Note that the indifference curve in Figure 3.2 slopes downward from left to right.
`To understand why this must be the case, suppose instead that it sloped upward
`from A to E. This would violate the assumption that more of any commodity is
`preferred to less. Because market basket E has more of both food and clothing than
`market basket A, it must he preferred to A and therefore cannot be on the same
`indifference curve as A. In fact, any market basket lying above and to the right of
`indifference curve U, in Figure 3.2 is preferred to any market basket on 1.1.1.
`
`Indifference Maps
`To describe a person's preferences for all combinations of food and clothing, we
`can graph a set of indifference curves called an indifference map. Each indif-
`ference curve in the map shows the market baskets among which the person
`is indifferent. Figure 3.3 shows three indifference curves that form part of an
`indifference map (the entire map includes an infinite number of such curves).
`Indifference curve U3 generates the highest level of satisfaction, followed b)
`indifference curves 1,12 and U,
`Indifference curves cannot intersect. To see why, we will assume the con-
`trary and see how the resulting graph violates our assumptions about consumer
`behavior. Figure 3.4 shows two indifference curves, U1 and LL, that intersect
`at A. Because A and B are both on indifference curve U,, the consumer must
`be indifferent between these two market baskets. Because both A and D lie or
`indifference curve U 2, the consumer is also indifferent between these market
`baskets. Consequently, using the assumption of transitivity, the consumer is also
`
`tt indifference map Graph
`containing a set of ndifference
`curves showing the market
`baskets among which a
`consumer is indifferent.
`
`Exhibit 2245
`Page 09 of 46
`
`

`

`Clothing
`(units per
`week)
`
`CHAPTER 3 • Consumer Behavior 73
`
`Clothing
`(units per
`week)
`
`Ui
`
`A
`
`U3
`
`Ua
`
`Food
`(units per week)
`
`•
`D
`
`Food
`(units per week)
`
`FIGURE 3.3
`AN INDIFFERENCE MAP
`An indifference map is a set of indifference curves that
`describes a person's preferences. Any market basket on
`indifference curve U3, such as basket A, is preferred to
`any basket on curve U2 (e.g., basket B), which in turn is
`preferred to any basket on U1, such as D.
`
`FIGURE 3.4
`INDIFFERENCE CURVES CANNOT INTERSECT
`If indifference curves U, and U, intersect, one of the
`assumptions of consumer theory is violated. Accord-
`ing to this diagram, the consumer should be indiffer-
`ent among market baskets A, B, and D. Yet B should be
`preferred to D because B has more of both goods.
`
`indifferent between B and D. But this conclusion can't be true: Market basket
`B must be preferred to D because it contains more of both food and clothing.
`Thus, intersecting indifference curves contradicts our assumption that more is
`preferred to less.
`Of course, there are an infinite number of nonintersecting indifference curves,
`one for every possible level of satisfaction. In fact, every possible market basket
`(each corresponding to a point on the graph) has an indifference curve passing
`through it.
`
`The Shape of Indifference Curves
`Recall that indifference curves are all downward sloping. In our example of
`food and clothing, when the amount of food increases along an indifference
`curve, the amount of clothing decreases. The fact that indifference curves slope
`downward follows directly from our assumption that more of a good is better
`than less. If an indifference curve sloped upward, a consumer would be indif-
`ferent between two market baskets even though one of them had more of both
`food and clothing.
`As we saw in Chapter 1, people face trade-offs. The shape of an indifference
`curve describes how a consumer is willing to substitute one good for another.
`Look, for example, at the indifference curve in Figure 3.5. Starting at market
`basket A and moving to basket B, we see that the consumer is willing to give up
`6 units of clothing to obtain 1 extra unit of food. However, in moving from B to
`U, he is willing to give up only 4 units of clothing to obtain an additional unit of
`
`Exhibit 2245
`Page 10 of 46
`
`

`

`74 PART 2 • Producers, Consumers, and Competitive Markets
`
`Clothing
`(units per
`week)
`
`16
`
`1
`4
`
`12
`
`10
`
`8
`
`6
`
`4
`
`2
`
`-6
`
`1
`
`-4
`
`1
`-2
`
`La
`
`1
`
`E
`
`1
`
`2
`
`3
`
`4
`
`5
`
`Food
`(units per week)
`
`FlGURE 3.5
`THE MARGINAL RATE
`OF SUBSTITUTION
`The magnitude of the slope of an indifference
`curve measures the consumer's marginal rate
`of substitution (MRS) between two goods. In
`this figure, the MRS between clothing (C) anc
`food (F) falls from 6 (between A and B) to 4
`(between B and D) to 2 (between D and El
`to 1 (between E and G). When the MRS
`diminishes along an indifference curve, the
`curve is convex.
`
`marginal rate of
`substitution (MRS)
`Maximum amount of a good that
`a consumer is willing to give up
`in order to obtain one additional
`unit of another good.
`
`food; in moving from D to E, he will give up only 2 units of clothing for 1 unit
`of food. The more clothing and the less food a person consumes, the more cloth-
`ing he will give up in order to obtain more food. Similarly, the more food that a
`person possesses, the less clothing he will give up for more food.
`
`The Marginal Rate of Substitution
`To quantify the amount of one good that a consumer will give up to obtain more
`of another, we use a measure called the marginal rate of substitution (MRS).
`The MRS of food F for clothing C is the maximum amount of clothing that a person it
`willing to give up to obtain one additional unit of food. Suppose, for example, the
`MRS is 3. This means that the consumer will give up 3 units of clothing to obtain
`1 additional unit of food. If the MRS is 1/2, the consumer is willing to give up
`only 1/2 unit of clothing. Thus, the MRS measures the value that the individuai
`places on 1 extra unit of a good in terms of another.
`Look again at Figure 3.5. Note that clothing appears on the vertical axis
`and food on the horizontal axis. When we describe the MRS, we must be clear
`about which good we are giving up and which we are getting more of. To be
`consistent throughout the book, we will define the MRS in terms of the amount
`of the good on the vertical axis that the consumer is willing to give up in order to
`obtain 1 extra unit of the good on the horizontal axis. Thus, in Figure 3.5 the MRS
`refers to the amount of clothing that the consumer is willing to give up to
`obtain an additional unit of food. If we denote the change in clothing by AC
`and the change in food by OF, the MRS can be written as —AC/AP We add
`the negative sign to make the marginal rate of substitution a positive num-
`ber. (Remember that AC is always negative; the consumer gives up clothing to
`obtain additional food.)
`
`Exhibit 2245
`Page 11 of 46
`
`

`

`CHAPTER 3 • Consumer Behavior 75
`
`Thus the MRS at any point is equal in magnitude to the slope of the indiffer-
`ence curve. In Figure 3.5, for example, the MRS between points A and B is 6: The
`consumer is willing to give up 6 units of clothing to obtain 1 additional unit of
`food. Between points B and D, however, the MRS is 4: With these quantities of
`food and clothing, the consumer is willing to give up only 4 units of clothing to
`obtain 1 additional unit of food.
`
`CONVEXITY Also observe in Figure 3.5 that the MRS falls as we move down
`the indifference curve. This is not a coincidence. This decline in the MRS reflects
`an important characteristic of consumer preferences. To understand this, we
`will add an additional assumption regarding consumer preferences to the three
`that we discussed earlier in this chapter (see page 70):
`
`4. Diminishing marginal rate of substitution: Indifference curves are usu-
`ally convex, or bowed inward. The term convex means that the slope of the
`indifference curve increases (i.e., becomes less negative) as we move down
`along the curve. In other words, an indifference curve is convex if the MRS
`diminishes along the curve. The indifference curve in Figure 3.5 is convex.
`As we have seen, starting with market basket A in Figure 3.5 and moving
`= —(-6)/1 = 6.
`to basket B, the MRS of food F for clothing C is —AC/
`However, when we start at basket B and move from B to D, the MRS falls
`to 4. If we start at basket D and move to E, the MRS is 2. Starting at E
`and moving to C, we get an MRS of 1. As, food consumption increases,
`the slope of the indifference curve falls in magnitude. Thus the MRS also
`falls.2
`
`is it reasonable to expect indifference curves to be convex? Yes. As more and
`more of one good is consumed, we can expect that a consumer will prefer to
`give up fewer and fewer units of a second good to get additional units of the
`first one. As we move down the indifference curve in Figure 3.5 and consump-
`tion of food increases, the additional satisfaction that a consumer gets from still
`more food will diminish. Thus, he will give up less and less clothing to obtain
`additional food.
`Another way of describing this principle is to say that consumers generally
`prefer balanced market baskets to market baskets that contain all of one good
`and none of another. Note from Figure 3.5 that a relatively balanced market bas-
`ket containing 3 units of food and 6 units of clothing (basket D) generates as
`much satisfaction as another market basket containing 1 unit of food and 16
`units of clothing (basket A). It follows that a balanced market basket containing,
`for example, 6 units of food and 8 units of clothing will generate a higher level
`of satisfaction.
`
`Perfect Substitutes and Perfect Complements
`The shape of an indifference curve describes the willingness of a consumer to
`substitute one good for another. An indifference curve with a different shape
`implies a different willingness to substitute. To see this principle, look at the two
`somewhat extreme cases illustrated in Figure 3.6.
`
`In §2.1, we explain that two
`goods are substitutes when
`an increase in the price of
`one leads to an increase in
`the quantity demanded of
`the other.
`
`'With 11011C011VCX preferences, the MRS increases as the amount of the good measured on the hori-
`zontal axis increases along any indifference curve. This unlikely possibility might arise if one or both
`goods arc addictive. For example, the willingness to substitute an addictive drug for other goods
`might increase as the use of the addictive drug increased.
`
`Exhibit 2245
`Page 12 of 46
`
`

`

`76 PART 2 • Producers, Consumers, and Competitive Markets
`
`(a) Perfect Substitutes
`
`(b) Perfect Complements
`
`Apple
`juice
`(glasses)
`
`Left
`shoes
`
`4
`
`3
`
`2
`
`1
`
`0
`
`It
`