Applications of Rational Choice and Demand Theories Chapter 5 – Part A Applications of Rational Choice and Demand Theories McGraw-Hill/Irwin Copyright © 2015 The McGraw-Hill Companies, Inc. All rights reserved.

Flat Grants versus Subsidies Income = $3 and PX = $1. So this person would be somewhere on the original budget constraint (indifference curve not shown). Suppose the government introduces a per unit subsidy program of $0.50 per unit on X -- to the consumer the price would fall from a dollar to 50 cents (and as such the person's budget constraint would rotate as shown above).

Flat Grants versus Subsidies If you want to make people as well off as possible, then simply transfer unrestricted cash to them. If you are more interested in them consuming good X, then do a per unit subsidy. How much did the government spend? At 50 cents a unit, it cost the government $1. The red line is the budget line if the government gives the consumer $1.00

Food Stamp versus Cash Grant under a Voucher System

Application: A Gasoline Tax And Rebate Policy Policy proposal made during the administration of President Jimmy Carter Goal: use gasoline taxes to help limit the quantity demanded of gasoline. Tax revenue would then be used to reduce the payroll tax (tax rebate). Would consumers buy the same amount of gasoline as before if the tax is rebated?

Copyright © 2013 Pearson Education, Inc Copyright © 2013 Pearson Education, Inc. • Microeconomics • Pindyck/Rubinfeld, 8e.

A Gasoline Tax and Rebate (text example)

The Intertemporal Choice Model How would rational consumers distribute their consumption over time? Two time periods: current and future. Two alternatives (goods): current consumption (C1) versus future consumption (C2).

The Intertemporal Choice Model Budget Constraint Present value: the present value of a payment of X dollars T years from now is X(1+ r)T, where r is the annual rate of interest. Present value of lifetime income: the horizontal intercept of the intertemporal budget constraint as the

Intertemporal Budget Constraint with Income in Both Periods, and Browsing or Lending at the Rate r Marginal rate of time preference: the number of units of consumption in the future a consumer would exchange for 1 unit of consumption in the present. It declines as one moves downward along an indifference curve.

The Optimal Intertemporal Allocation

Patience and Impatience

The Effect of a Rise in the Interest Rate

Labor - Leisure

Labor - Leisure

Labor Supply Curve