2 - budget constraints Flashcards
what is a consumption choice set?
A consumption choice set is the collection of all consumption choices available to the consumer.
what constrains consumption choice?
Budgetary, time, calories, and other resource limitations
what is a budget set?
the set of all affordable bundles
what is a budget line?
the line connecting all the consumption bundles on which the whole budget is spent
what is the equation of the budget line?
x2=M/P2 - P1*x1/P2
what is the equation of the budget line slope?
- p1/p2
what does the slope of the budget line represent?
it measures the opportunity cost of consuming good 1
what is the numeraire price?
it is the price relative to which we are measuring the other price and income
what occurs to the budget line when there is an increase in income?
when there is an increase in income there is a parallel shift outward of the budget line
what occurs to the slope of the budget line when there is an increase in income
the slope is unaffected by an increase in incoem
what occurs when there is an increase in the price of good 1 but good 2 and M remain the same?
good 1 will become relatively more expensive and therefore it is possible to buy the smaller quantity of good 1 with same income. therefore the budget line will rotate around the good 2 axis causing the budget line to intersect at a smaller quantity of good 1. the slope will increase as p1/p2 will be greater as p1 has increased whilst p2 is the same
what is a quantity tax?
suppose consumer has to pay a fixed amount of tax per each unit of product bought
what occurs to the budget line when there is a quantity tax?
suppose the consumer has to pay a fixed amount of t per each unit of product 1 bought then the price of product 1 will increase from p1 to p1+t. as a result the budget line will rotate around good 2 axis and will intersect the good 1 axis as a lower quantity. the curve will be steeper
what occurs to the budget line when there is a subsidy?
suppose the consumer has a subsidy of size s on each unit of product 1 bought. this will mean the price they are paying is equal to p1 - s . as a result, there will be a rotation along the good 2 axis and cause the good 1 axis intercept to be greater. this will result in a flatter slope
what is an ad valorem tax?
consumers pay extra percentage on the price
how will an ad valorem tax on good 1 affect the slope of the budget line?
the price of good 1 will change from p1 to p1(1+t) meaning the slope of the budget line will change to p1(1+t)/p2
what occurs to the budget line when a VAT is introduced for all goods>
if a uniform VAT of 20% is added to all goods, then the price of all goods will increase by 1.2 x . as a result, there will be an inward shift of the budget line resulting in the new intercepts being M/[p2(1+t)] for the x2 axis and M/[p1(1+t)] for the x1 axis. however the slope of the budget line will remain the same as the vat will cancel out leaving only p1/p2 as the slope
what occurs to the budget line if the prices depend on the quantity bought ie bulk discount?
if the prices depend on the quantity bought then the budget constraint will no longer be a linear function
how can you represent a bulk discount on a budget line?
you can show it by a kinked budget line. assume there is a bulk discount on good x so up to 20 goods it costs 2 pounds but after 20 it costs 1 pound. this will result in the slope halving in steepness at 20 goods of good x1
how can you show rationing constraints on a budget line?
you can show rationing on a budget line by the budget line decreasing at a fixed rate until the rationing limit has been reached then no more of the good can be consumed so as a result the line is straight down to the axis
