The Budget Constraint

Question 1

What does the general choice set equation set out?

Answer 1

It says that the choice set is equal to combinations of x1 and x2 that are real and non-negative such that the mathematical expression to the right of | is satisfied

Question 2

What is a composite good?

Answer 2

A good representing all the other goods to choose from compared to another good

Question 3

Why would we use composite goods in analysis?

Answer 3

When analysing the choice set for n number of goods, we can use the composite good to simplify the model and not need n axes

Question 4

In the general choice set equation, what is the inequality to the right of | and what does it express?

Answer 4

p1x1 + p2x2 ≤ m

This means that the money an individual spends on goods cannot exceed their income.

Question 5

In the choice set for endogenous income, what is the inequality to the right of | and what does it express?

Answer 5

p1x1 + p2x2 ≤ p1ω1 + p2ω2

This means that the money an individual spends on goods cannot exceed their endowment

Question 6

When looking at endogenous income, what is the effective income?

Answer 6

Income is effectively the value of the goods with which one is endowed

Question 7

What point does the endogenous income budget line have to go through?

Answer 7

(ω1, ω2) which is the endowment

Question 8

When do capital markets function perfectly, and how does it affect the interest rate (r)?

Answer 8

When the supply of loanable funds is equal to thte demand for loanable funds. This means that the interest rate for borrowing is the same as the interest rate for saving

Question 9

When considering the budget constraint over time, what do we need to be equal?

Answer 9

Present value of expenditure = Present value of income

Question 10

What is the principal equation for the present value of expenditure being equal to the present value of income?

Answer 10

p0c0 + (p1c1/1+r) = p0m0 + (p1m1/1+r)

Question 11

What point does the intertemporal budget constraint have to pass through?

Answer 11

(m0,m1)

Question 12

How is the intertemporal budget constraint affected if there’s no inflation and a fall in the nominal interest rate?

Answer 12

It rotates to become more flat about point (m0,m1)

Question 13

What is the budget constraint representing the trade-off between consumption and leisure?

Answer 13

pC = S + wL
p=price of consumption
S=non-wage income
w=wage
L=hours worked

Question 14

What is the time constant in the consumption-leisure budget constraint?

Answer 14

L + R = T
R=rest
L=leisure
T=time