9:59:59.000,9:59:59.000 ♪ [music] ♪ 9:59:59.000,9:59:59.000 To get a better understanding[br]of how we make choices, 9:59:59.000,9:59:59.000 we first need to understand [br]the elements that go 9:59:59.000,9:59:59.000 into making a decision. 9:59:59.000,9:59:59.000 And not all of them are [br]within our control. 9:59:59.000,9:59:59.000 The world is constantly, [br]invisibly determining the prices 9:59:59.000,9:59:59.000 of goods and services. 9:59:59.000,9:59:59.000 Take the price of a cup of coffee. 9:59:59.000,9:59:59.000 It depends on so many variables. 9:59:59.000,9:59:59.000 Think culture, demographics, [br]the cost of beans, the weather, 9:59:59.000,9:59:59.000 the supply and demand for oil, 9:59:59.000,9:59:59.000 even the high rent at your hip [br]neighborhood coffee shop. 9:59:59.000,9:59:59.000 You get the idea. 9:59:59.000,9:59:59.000 All of this economic activity is [br]magically being simplified 9:59:59.000,9:59:59.000 into a price for a cup of coffee. 9:59:59.000,9:59:59.000 How about your salary -- the price [br]of one hour of your labor? 9:59:59.000,9:59:59.000 It depends on you, of course,[br]on your skills and effort, 9:59:59.000,9:59:59.000 but it also depends [br]on many factors outside 9:59:59.000,9:59:59.000 of your control -- for example, [br]the demand for your services, 9:59:59.000,9:59:59.000 nearby competition, [br]even how fun your job is. 9:59:59.000,9:59:59.000 Every day you make decision [br]after decision about what to buy, 9:59:59.000,9:59:59.000 comparing hundreds [br]of different goods and services. 9:59:59.000,9:59:59.000 There are so many choices. 9:59:59.000,9:59:59.000 To simplify things, let's think [br]about what you would do 9:59:59.000,9:59:59.000 if you had a weekly budget of $50[br]to spend on just two goods, 9:59:59.000,9:59:59.000 coffee and pizza. 9:59:59.000,9:59:59.000 Coffee costs $5 and pizza cost $10. 9:59:59.000,9:59:59.000 So pizza is twice [br]as expensive as coffee. 9:59:59.000,9:59:59.000 There are several different [br]combinations of coffee and pizza 9:59:59.000,9:59:59.000 you could buy with this money. 9:59:59.000,9:59:59.000 Let's plot a few [br]of your options on a graph. 9:59:59.000,9:59:59.000 On the "x"-axis, we have the number[br]of pizzas per week. 9:59:59.000,9:59:59.000 And on the "y"-axis, we have[br]the cups of coffee per week. 9:59:59.000,9:59:59.000 You could buy two cups of coffee[br]and four pizzas, 9:59:59.000,9:59:59.000 four cups of coffee [br]and three pizzas, 9:59:59.000,9:59:59.000 five pizzas with no coffee, 9:59:59.000,9:59:59.000 or 10 cups of coffee but no pizza. 9:59:59.000,9:59:59.000 When you connect [br]to different options that represent 9:59:59.000,9:59:59.000 the ways you can spend your $50,[br]you get a straight line. 9:59:59.000,9:59:59.000 This is your budget constraint. 9:59:59.000,9:59:59.000 And it represents all possible [br]combinations of coffee and pizza 9:59:59.000,9:59:59.000 you can buy -- given your budget[br]and the prices of coffee and pizza. 9:59:59.000,9:59:59.000 This budget line also separates [br]what you can afford 9:59:59.000,9:59:59.000 from what you cannot afford. 9:59:59.000,9:59:59.000 Maybe you wish you could buy[br]two cups of coffee and six pizzas, 9:59:59.000,9:59:59.000 or four cups of coffee [br]and 10 pizzas. 9:59:59.000,9:59:59.000 But these are not in your budget. 9:59:59.000,9:59:59.000 Sorry. 9:59:59.000,9:59:59.000 All these different combinations[br]cost more than you have. 9:59:59.000,9:59:59.000 So they're unaffordable,[br]given your budget 9:59:59.000,9:59:59.000 and the prices of these two goods. 9:59:59.000,9:59:59.000 Combinations of coffee and pizza[br]below the budget line, 9:59:59.000,9:59:59.000 on the other hand, [br]are within your means. 9:59:59.000,9:59:59.000 So they're affordable, 9:59:59.000,9:59:59.000 and you could buy them[br]if you wanted. 9:59:59.000,9:59:59.000 The budget constraint also reflects[br]how the market substitutes 9:59:59.000,9:59:59.000 between the two goods. 9:59:59.000,9:59:59.000 Remember, pizzas are twice[br]as expensive as coffee. 9:59:59.000,9:59:59.000 And this simply means [br]that the relative price 9:59:59.000,9:59:59.000 of one pizza is two cups of coffee. 9:59:59.000,9:59:59.000 You see this on the slope[br]of the budget constraint, 9:59:59.000,9:59:59.000 which is 2. 9:59:59.000,9:59:59.000 Well, actually it's -2,[br]but we're less concerned 9:59:59.000,9:59:59.000 about the sign. 9:59:59.000,9:59:59.000 Although, it does remind us[br]that having more of one good 9:59:59.000,9:59:59.000 requires giving up [br]some of the other. 9:59:59.000,9:59:59.000 When coffee costs $5,[br]and pizzas cost $10, 9:59:59.000,9:59:59.000 if you want an additional pizza,[br]you have to give up 9:59:59.000,9:59:59.000 two cups of coffee. 9:59:59.000,9:59:59.000 If this made you think [br]about opportunity cost, 9:59:59.000,9:59:59.000 you're right! 9:59:59.000,9:59:59.000 The slope of the budget constraint [br]is the opportunity cost of pizza. 9:59:59.000,9:59:59.000 Will this tradeoff change[br]if your budget increases -- 9:59:59.000,9:59:59.000 say, if you find a $20 bill[br]in the pocket of your winter jacket 9:59:59.000,9:59:59.000 and now have $70 to spend[br]on these two goods? 9:59:59.000,9:59:59.000 No -- the tradeoff is given [br]by the market's prices. 9:59:59.000,9:59:59.000 So changes in your income [br]do not affect the relative price 9:59:59.000,9:59:59.000 of goods. 9:59:59.000,9:59:59.000 Sure -- you'll be able to afford[br]and choose between 9:59:59.000,9:59:59.000 all of the consumption combinations[br]that total $70. 9:59:59.000,9:59:59.000 And you can see how this makes [br]your budget constraint 9:59:59.000,9:59:59.000 shift outward. 9:59:59.000,9:59:59.000 But, the two cups of coffee[br]for one pizza tradeoff 9:59:59.000,9:59:59.000 remains the same. 9:59:59.000,9:59:59.000 And that is because the market[br]still values these two goods 9:59:59.000,9:59:59.000 relative to one another[br]just like it did before. 9:59:59.000,9:59:59.000 This tradeoff does change[br]if the relative price 9:59:59.000,9:59:59.000 of the two goods changes. 9:59:59.000,9:59:59.000 Think of what will happen if maybe 9:59:59.000,9:59:59.000 because of unusually good weather[br]the price of coffee falls 9:59:59.000,9:59:59.000 from $5 to $2.50. 9:59:59.000,9:59:59.000 Does the market tradeoff [br]remain the same? 9:59:59.000,9:59:59.000 No. 9:59:59.000,9:59:59.000 Pizza's just became four times [br]more expensive than coffee. 9:59:59.000,9:59:59.000 So you're able to buy four cups[br]of coffee, when you give up 9:59:59.000,9:59:59.000 eating one pizza. 9:59:59.000,9:59:59.000 This will make your budget [br]constraint rotate outward. 9:59:59.000,9:59:59.000 Notice how because nothing[br]happened to the price of pizza, 9:59:59.000,9:59:59.000 the number of pizzas you can buy [br]when you don't buy coffee 9:59:59.000,9:59:59.000 hasn't changed. 9:59:59.000,9:59:59.000 You can still only buy five pizzas. 9:59:59.000,9:59:59.000 But, if you spend [br]all of your budget on coffee, 9:59:59.000,9:59:59.000 just look at how many more [br]cups of coffee you can buy. 9:59:59.000,9:59:59.000 You can now buy [br]20 cups of coffee per week. 9:59:59.000,9:59:59.000 That's a lot of coffee. 9:59:59.000,9:59:59.000 You see -- the new higher [br]relative price of pizza, 9:59:59.000,9:59:59.000 in terms of coffee,[br]in the slope 9:59:59.000,9:59:59.000 of the new budget constraint,[br]which is now 4. 9:59:59.000,9:59:59.000 We make choices every day --[br]the reality of what we can afford, 9:59:59.000,9:59:59.000 given by our incomes [br]and the prices of goods 9:59:59.000,9:59:59.000 and services, are all [br]very important elements 9:59:59.000,9:59:59.000 that affect our decisions. 9:59:59.000,9:59:59.000 But there are other elements[br]equally important, 9:59:59.000,9:59:59.000 and those are our preferences. 9:59:59.000,9:59:59.000 We'll examine these next. 9:59:59.000,9:59:59.000 - [Narrator] You're on your way[br]to mastering economics. 9:59:59.000,9:59:59.000 Make sure this video sticks,[br]by taking a few practice questions. 9:59:59.000,9:59:59.000 Or, if you're ready for more[br]Microeconomics, 9:59:59.000,9:59:59.000 click for the next video. 9:59:59.000,9:59:59.000 ♪ [music] ♪ 9:59:59.000,9:59:59.000 Still here? 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