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Topic 3 - Budget Constraints

(Lecture 2 Sept 21st)

Intuition:

1. Goods: x1, x2;

2. Price: p1, p2

3. E: total expenditure/budget the individual has;

Assume that all of E is spent, E = p1x1 + p2x2

Y-intercepts:

= maximum units of x2 that can be consumed;

Slope:

= OC = Units of x2 that have to be reduced to consume one more unit of x1;

-- Change in Variables:

x2 x2 x2

x1 x1 x1

E shifts outward p1 steeper p2 flatter

-- Non-linear Constraint budget x2

Liner budget constraint = assumption that prices are fixed;

In the real world, there might be non-linearity of prices

e.g. price of electricity depends on usage

x1<a, p1;

x1>a,2p1;

x2,p2 a x1

Inter- temporal Budget Constraint

Assume Y1,Y2 “income” in two periods;

x1p1 + x2p2 = Y1+Y2 x1 =