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In this chapter, we take a deeper look at how rational consumers choose. In previous chapters, we analyzed a fairly simple choice. What should a consumer do when the price of a good falls? Buy more! That was easy. In this chapter, we look at more complicated choices such as whether a consumer should shop at Costco. Costco, like Sam’s Club or BJ’s, offers lower prices, but to shop there, you have to pay a membership fee. How much will consumers be willing to pay to shop at Costco? As you might imagine, this is a key question for Costco managers!

We will also be looking at how much labor a worker should supply in response to a lower wage. In our chapter on labor supply, we pointed out that a worker might respond to a lower wage by working less (called the substitution effect) or the worker might choose to work more to make up for the shortfall in income at the lower wage (the income effect). In this chapter, we introduce two new tools—budget constraints and indifference curves—that will help us understand in greater detail the substitution and income effects, and how consumers and workers choose when faced with complicated decisions.