Economics 2150A/B Lecture Notes - Lecture 4: Budget Constraint, Internetwork Packet Exchange, International Polar Year
15 Jun 2018
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Department
Course
Professor
Econ 2150
Chapter 4 Textbook Notes
Oct. 2 2017
Chapter 4: Consumer Choice
The Budget Constraint
ā¢ Budget constraint = defines set of baskets that a consumer can purchase with a limited
amount of income
ā¢ The budget line indicates all the combinations of 2 goods (x and y) that a consumer can
purchase if they spend all their available income on the 2 goods
o Expressed as: PxX + PyY = I
āŖ Means the price of good x times the # of units, plus that of good y equals
income
ā¢ Budget constraint is expressed as PxX + PyY is less than or equal to I
o Because we can afford goods both on the line or under it
ā¢ ālope of īudget liī
¶e is āī/āī
o Tells us how many units of the good on the vertical axis a consumer must give up
to obtain an additional unit of the good on the horizontal axis
o āPx/Py
How Does a Change in Income Affect the Budget Line
ā¢ when income rises, set of choice available increases
o slope remains same, shift budget line outward
How Does a Change in Price Affect the Budget Line?
ā¢ Vertical intercept (I/Py) of budget line remains same
o Because I and P do not change
ā¢ Horizontal intercept (I/Px) decreases if Price increases
o Changes the slope of budget line
o Coī
¶suī
µerās purīhasiī
¶g poīer deīreases īeīause set of īhoiīes has deīliī
¶ed
Optimal Choice
ā¢ Optimal choice = the optimal amount of each good to purchase
o Maximizes utility
o Allows them to live within their budget constraint
ā¢ No point inside the budget line is optimal because we are not using all our income
ā¢ U(x, y) represents the consuī
µerās utilitī froī
µ purīhasiī
¶g ī uī
¶its of oī
¶e good, aī
¶d ī
units of another
o Must choose while still satisfying budget constraint (PxX + PyY is less than or
equal to I)
ā¢ Choice problem is expressed as:
o Maxx U(x, y) subject to PxX + PyY is less than or equal to I
āŖ An optimal choice will be EQUAL to I
ā¢ To max utility, choose the highest indifference curve that is still on/inside budget line
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ECON 2150A/B Full Course Notes
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Document Summary
How does a change in income affect the budget line: when income rises, set of choice available increases, slope remains same, shift budget line outward. Using the tangency condition to understand when a basket is not optimal: at a point on the curve that is not at the bow, (cid:3299)(cid:3300)(cid:1856)(cid:1867)(cid:1857)(cid:1871) (cid:1866)(cid:1867)(cid:1872) (cid:1857)(cid:1873)(cid:3299)(cid:3300, (cid:3299)(cid:3299) =(cid:3300) What basket requires the lowest expenditure to reach indifferences curve u2. Corner points: a consumer may not purchase positive amounts of all available goods. Consumer choice with composite goods: good o(cid:374) the (cid:448)erti(cid:272)al a(cid:454)is is (cid:272)alled a (cid:272)o(cid:373)posite good (cid:271)e(cid:272)ause it is the (cid:272)o(cid:373)posite of (cid:862)all other goods(cid:863) Ie you model consumer behaviour for food, and all other goods: price of a unit of the composite good is py = 1. Application: joining a club let"s the(cid:373) pur(cid:272)hase goods & ser(cid:448)i(cid:272)es at a dis(cid:272)ou(cid:374)t joining a club produces a long, shallower budget line.
