Budget Constraints

Question 1

What is the buyer’s problem?

Answer 1

• What do you like? And how much do you like it? (Unlimited Wants)
• How much does it cost? (Constraint)
• How much money do you have? (Constraint)

Question 2

What assumptions do economists make about consumer tastes and preferences?

Answer 2

We all want the best value products – the most for our money

What we buy reflects our tastes and preferences (revealed preferences)

Question 3

What assumptions do economists make about the price of goods and services?

Answer 3

o Prices are fixed (no negotiation)

o We can buy as much as we want of something without driving the price up
This is because each individual is a small part of the overall market

Question 4

What assumptions do economists make about consumer budgets?

Answer 4

There is no saving/borrowing, only buying

Even though we use a straight line to represent purchase choices, we only purchase whole units

Question 5

What does the budget constraint represent?

Answer 5

• At every point on the budget constraint, we are spending all of our income

Question 6

How do you find the equation of the budget constraint?

Answer 6

Expenditure on Good X + Expenditure on Good Y = Income

Otherwise Expressed as PxQx+ PyQy = I

Question 7

How can you express the BC equation as y=mx+b?

Answer 7

Question 8

What is an alternate way of finding the BC slope?

Answer 8

Question 9

How does the budget constraint relate to opportunity cost?

Answer 9

As you increase consumption of sweaters you have to forgo the number of jeans you
can buy
o This is the opportunity cost of buying more sweaters

• This can be found by placing the price of sweaters over the price of jeans
• PS/PJ = ½
  o Therefore, the opportunity cost of 1 sweater is ½ a pair of jeans
• The slope is the price of the good on the x axis over the price of the good on the y axis - the opportunity cost of good y
• Any decrease in the size of a feasible set indicates the individual is less well off