Chapter 2 Budget Constraint Key Concepts: Budget Set, Budget Line The slope of the budget line represents how many units of y you have to give up for an additional unit of x, i.e. the opportunity cost of a unit of x.

Chapter 2 Budget Constraint Suppose there are two goods that a consumer can choose. We indicate a consumption bundle by (x1, x2).

The budget constraint can be expressed as p1x1 + p2 x2 ≤ m m is the amount of money the consumer has to spend (p1, p2) are the prices of the two goods

Draw the budget set.

Fig. 2.1

The slope –p1/ p2 increase one unit of good 1, how many units of good 2 that you have to decrease p1 = 6, p2 = 3 6/3 = 2 p1 ∆x1 + p2 ∆x2 = 0 and ∆x2/ ∆x1 = –p1/ p2

Two goods are often enough. p1x1 + x2 ≤ m x2: money spent on all other goods, a composite good

Change of the budget line m↑?

Fig. 2.2

p1↑?

Fig. 2.3

m, p1, p2 ↑at the same rate? only relative prices (in real terms) matter money illusion

We don’t like a pay cut. But is pay cut really a cut?

Sell a house after one year Adam -23%, Ben -1%, Carl 23% -25%, 0%, 25% Most successful? 48% vote for Carl

2500 NTD or 2500 Yen 2500 = 2.5 ramen

Rationing on good 1?

Fig. 2.4

Imposing a consumption quantity tax t on good 1 only when the consumption of good 1 is in excess of x1*?

Fig. 2.5

Giving some amount of food stamps for free?

Fig. 2.6

Giving free education subsidy but once you accept, cannot buy more or less

AOG education

Only relative prices matter. Absolute prices don’t matter. If the budget set is larger, consumers are weakly better off.

Chapter 2 Budget Constraint Key Concepts: Budget Set, Budget Line The slope of the budget line represents how many units of y you have to give up for an additional unit of x, i.e. the opportunity cost of a unit of x.