1. A2 Economics Mr. Durham durham.j@shishialevel.cn

2. Lesson Objectives
To be able to explain what a budget line is and the effect to a budget line of changes in income and change in prices
Understand the exceptions to the law of demand, and to differentiate the causes of Giffen Goods and Veblen Goods

3. Past FRQ
Activity: Create a marking scheme for this past CIE final exam paper
Choice is an essential part of the analysis in economic texts
Explain how economic analysis suggests that consumers make a choice when buying products and how they react to price changes (12 points)

4. Budget Lines
Definition: A budget line shows the various combinations of two products that a consumer can buy given his/her income and given prices
Consumption Bundle: the combination of 2 (or more) goods that a consumer can consume
E.g. 3 pizzas and 0 Cokes
E.g. 0 pizzas, and 12 cokes
Budget Constraint Rule:
Expenditure A + Expenditure B < or = Budget
Consumer must choose a consumption bundle that costs no more than his budget

5. Budget Lines
Consumption Possibilities: all of the different consumption bundles, that are affordable to a consumer, given his budget
Activity: Given the following information, what are the consumption possibilities for a person who will spend his entire budget on clams and potatoes?
Budget = $20
Potatoes = $2 / pound
Clams = $4 / pound

6. Activity: Consumption Possibilities

7. Activity: Budget Line

8. Budget Lines and Tradeoffs
Downward Sloping: moving from one point on the budget line to another point on the budget line requires a tradeoff.
Example: Moving from point A (0 Clams, 10 potatoes) to point B (1 Clam, 8 potatoes)
The Opportunity Cost of consuming more clams is consuming fewer potatoes.

9. Budget Lines Note: Bundles outside the budget line are unaffordable
Bundles inside the budget line are ignored, assuming
The MU of consuming each good is positive in the bundles
The person does not receive utility from saving money
We assume all of the budget is spent on the 2 goods

10. Budget Lines - Changes Shifts – Caused by Income Change
Increase in income causes the budget line to shift out
Pivots – Caused by Price Change
If the price of “only one” good “decreases”. The line will shift out
Uneven shift – Causes by 2 Price changes
Where the two goods change in price by a different relative amount

11. Budget Lines - Changes

12. Budget Lines - Changes

13. Law of Demand - Exceptions
Where the there is a positive relationship between quantity demanded and price
Leading to an upward sloping demand curve
Giffen Goods
Veblen Goods

14. Giffen Goods
Demand increases as price increases – falls when price decreases
Upward sloping demand curve
Inferior good with no easily available substitutes
The income effect “dominates” the substitution effect
Higher price means people cant buy “better goods”. No substitutes available, so demand for the inferior good goes up
Quite Rare
Examples
Ireland – Potatoes (Robert Giffen)
China – Hunan Rice (Harvard Study)

15. Veblen Goods Demand increases as price increases
Upward sloping demand curve
Exclusive nature and status symbol
Demand is a reflection of consumer taste
Contrast with Giffen Goods: Demand is a result of few substitutes
Quite Common. Luxury goods with strong brand appeal
Business Note: Lower the price and demand will drop sharply. The snob appeal is lost, and its still too expensive for most.
Example: Coach Handbags

16. Homework Complete Equi-Marginal Activity Question
uploaded to wikispaces page
2 Extension questions for “extra” practice
Please bring your written solutions to my attention should you choose to answer these.
Next Topic: Indifference Curves

17. Downward Sloping D Curve
Extra Question: Jennifer has an entertainment budget of $200 per semester, which she divides among purchasing CDs, going to concerts, eating in restaurants, and so forth. When the price of CDs fell from $20 to $10, her purchases rose from 5 per semester to 10 per semester. When asked how many she would have bought if her budget constraint were $150 (since with $150 she could continue to buy 5 CDs and as before still have $100 for spending on other items), she said she would have bought 8 CDs. What is the size of her substitution effect? Her income effect? Are CDs normal or inferior for her?

18. Downward Sloping D Curve
Extra Question: The fact that income and substitution effects move in opposite directions in the case of inferior goods raises a tantalizing possibility: What if the income effect were the stronger of the two? Could demand curves be upward sloping?