Microeconomic Theory
SAROO0OON
webpage_3.pdf
Consumer Budgets
Intermediate Micro Theory ECN 312
From Last Class
• Preferences describe consumers’ opinions on the happiness they would receive from any bundle of goods.
• But, what will they choose? How do they decide?
• Lines up to readings for Chapters 2 and 4
From Last Class
Preferences Budget (Income)
Choice (Individual Demand)
Population
Market Demand
From Last Class
Preferences Budget (Income)
Choice (Individual Demand)
Population
Market Demand
Budgets
• First go over how we can represent budgets graphically
• Second go over how we can represent budgets mathematically
Budgets
• Suppose that you live in an economy with two goods: food (F) and clothing (C)
• These goods have prices: PF = $2 and PC = $3
• You have income of $30
Affordability
• Which bundles can we afford? How can we show this information graphically?
– Same set of axes we used for preferences (ICs)
– What if we spent all of our money on F? What if we spent all our money on C? (this gives intercepts)
– What if we spent some of our money on F and some of our money on C?
Affordability Clothing
Food
PF = 2 and PC = 3 Income = 30
Affordability Clothing
Food
PF = 2 and PC = 3 Income = 30
What if we spend all our money on C?
Affordability Clothing
Food
PF = 2 and PC = 3 Income = 30
What if we spend all our money on C?
10
Affordability Clothing
Food
PF = 2 and PC = 3 Income = 30
What if we spend all our money on F?
10
Affordability Clothing
Food
PF = 2 and PC = 3 Income = 30
What if we spend all our money on F?
10
15
Affordability Clothing
Food
PF = 2 and PC = 3 Income = 30
What if we spend some money of C
and some money on F?
10
15
Affordability Clothing
Food
PF = 2 and PC = 3 Income = 30
10
15
Affordability Clothing
Food
PF = 2 and PC = 3 Income = 30
10
15
Affordability Clothing
Food
PF = 2 and PC = 3 Income = 30
10
15
Slope = - 2 3
Quick Preview Clothing
Food
C
B
A
Quick Preview Clothing
Food
C
B
A
Which one will make you the
happiest?
Quick Preview Clothing
Food
C
B
A
Which one will make you the
happiest?
Which one will
you choose?
• Budget constraint - Total spending must be no greater than income:
PF*F + PC*C ≤ Income In this case: 2*F + 3*C ≤ 30
• Budget set - The collection of affordable bundles: All (F,C) such that PF*F + PC*C ≤ Income
• Budget line - The collection of bundles that exhaust a consumer’s income:
All (F,C) such that PF*F + PC*C = Income In this case: C = 10 – (2/3)F
Budgets
Budgets
In general, consider N goods in the economy (X1, X2, X3, …, XN ) with prices (P1, P2, P3, …, PN) and consumer income (I)
• The budget constraint is: P1 X1 + P2 X2 + P3 X3 + … + PN XN ≤ I
Σ Pi Xi ≤ I
• The budget set is all combos of X1, X2, X3, …, XN that satisfy the constraint
• The budget line is: Σ Pi Xi = I
i= 1
N
i= 1
N
Illustrating Budget Constraints y
x
Finding the Intercept: y-intercept Income divided by Py x-intercept Income divided by Px
Illustrating Budget Constraints y
x
Finding the Intercept: y-intercept Income divided by Py x-intercept Income divided by Px
I Py
I Px
Illustrating Budget Constraints y
x
Finding the Intercept: y-intercept Income divided by Py x-intercept Income divided by Px
I Py
I Px
Illustrating Budget Constraints y
x
Finding the Intercept: y-intercept Income divided by Py x-intercept Income divided by Px
I Py
I Px
Finding the Slope: slope -(Px divided by Py)
Px Py
-
Illustrating Budget Constraints C
F
Finding the Intercept: y-intercept 30 divided by 3 x-intercept 30 divided by 2
30 3
30 2
Finding the Slope: slope -(2 divided by 3)
2 3
-
Illustrating Budget Constraints C
F
Income = 30 PC = 3 PF = 2
10
15
2 3
-
Income Changes C
F
Income = 30 PC = 3 PF = 2
10
15
2 3
-
But what if income
increases to 45?
Income Changes C
F
Income = 45 PC = 3 PF = 2
10
15
2 3
-
15
22.5
Income Changes C
F
Income = 45 PC = 3 PF = 2
10
15
2 3
-
and if income
had fallen to 15…
15
22.5
Income Changes y
x
Income = 15 PC = 3 PF = 2
10
15
2 3
-5
7.5
Income Changes y
x
Income = 30 PC = 3 PF = 2
10
15
2 3
-
What if we see a change in the prices of C and F?
Income Changes C
F
Income = 30 PC = 3 PF = 2
10
15
2 3
-
What if we see a change in the prices of C and F?
What if the price of clothing
increases to 5?
Price Changes C
F
Income = 30 PC = 5 PF = 2
10
15
2 3
-
6
- 2 5
Price Changes C
F
Income = 30 PC = 5 PF = 2
10
15
2 3
-
6
- 2 5
What if the price of food had fallen to 1.50 instead?
Price Changes C
F
Income = 30 PC = 3 PF = 1.50
10
15
2 3
- - 1 2
20
Economic Interpretation
• Slope of the budget line:
– The rate at which the market is willing to trade y for x. (negative slope)
– If you want another unit of x, you have to buy it for Px. In order to get Px dollars, you need to sell some of your y.
• To raise $1, you need to sell 1/ Py units of y.
• To raise Px dollars, you need to sell Px / Py units of y.
• Similar to MRS…
Kinked Budget Sets
• So far, prices have been constant per unit: – The price of food was $2 for all quantities.
• In the “real world,” many prices vary with quantity. – Sam’s Club membership of $35
• First unit of food has price = 35 + PF • Second unit of food has price = PF
– Cell phone service
– Quantity discounts
– Certain taxes
Example: Kinked Budget Sets
• You live in a school district with a good public school and one good tutor, who provides an identical good of quality education. – The school provides 30 hours per week free. – The tutor provides the first 5 hours per week at $10/hour – The tutor provides time after 5 hours at $20/hour
• The only other product in the market is food (F), which is sold at $1 per unit
• Your weekly income is $250
Example: Kinked Budget Sets
• You live in a school district with a good public school and one good tutor, who provides an identical good of quality education. – The school provides 30 hours per week free. – The tutor provides the first 5 hours per week at $10/hour – The tutor provides time after 5 hours at $20/hour
• The only other product in the market is food (F), which is sold at $1 per unit
• Your weekly income is $250 What does your budget line look like?
Example: Kinked Budget Sets Food
Education
Example: Kinked Budget Sets Food
Education
Spend all money on
food….
Example: Kinked Budget Sets Food
Education
Spend all money on
food….
250
Example: Kinked Budget Sets Food
Education
Spend all money on
education…
250
Example: Kinked Budget Sets Food
Education
Spend all money on
education…
250
45
Example: Kinked Budget Sets Food
Education
250
4530 35
Example: Kinked Budget Sets Food
Education
250
4530 35
What is the slope of the BL between 0 and
30 hours of education?
Example: Kinked Budget Sets Food
Education
250
4530 35
Slope = 0
Example: Kinked Budget Sets Food
Education
250
4530 35
Slope = 0
What is the slope of the BL
between 30 and 35 hours of education?
Example: Kinked Budget Sets Food
Education
250
4530 35
Slope = 0
Slope = -10
Example: Kinked Budget Sets Food
Education
250
4530 35
Slope = 0
Slope = -10
What is the slope of the BL
between 35 and 45 hours of education?
Example: Kinked Budget Sets Food
Education
250
4530 35
Slope = 0
Slope = -10
Slope = -20
Budgets
• Consumers’ choices are limited by what they can afford
• We display all feasible bundles graphically with budget lines/budget sets
• Main concepts: – Finding the slope and intercepts of budget line
– Interpreting of slope of BC analogous to interpreting the slope of IC
– Incorporating more complicated pricing schemes with kinked budget lines.
Preview
• How consumers make decisions depends fundamentally on the difference between:
1. How they are willing to trade good x for good y
2. How the market trades good x for good y
• An example from my MBA Environment class…..
Economic Efficiency
• Bahamas on a budget -- $400 – 3 days in a tent – Willing to pay $550
• Midrange trip -- $600 – 4 days in the airport Motel 6 – Willing to pay $900
• Luxury trip -- $850 – 5 days in beachside hotel – Willing to pay $1100
• Ultra Luxury Weeklong trip -- $1250 – 7 days in a deluxe waterfront cabana – Willing to pay $1250
Economic Efficiency
• Bahamas on a budget -- $400 – 3 days in a tent – Willing to pay $550
• Midrange trip -- $600 – 4 days in the airport Motel 6 – Willing to pay $900
• Luxury trip -- $850 – 5 days in beachside hotel – Willing to pay $1100
• Ultra Luxury Weeklong trip -- $1250 – 7 days in a deluxe waterfront cabana – Willing to pay $1250
Net Benefits = $0
Economic Efficiency
• Bahamas on a budget -- $400 – 3 days in a tent – Willing to pay $550
• Midrange trip -- $600 – 4 days in the airport Motel 6 – Willing to pay $900
• Luxury trip -- $850 – 5 days in beachside hotel – Willing to pay $1100
• Ultra Luxury Weeklong trip -- $1250 – 7 days in a deluxe waterfront cabana – Willing to pay $1250
Net Benefits = $0
Net Benefits = $250
Net Benefits = $300
Net Benefits = $150
Economic Efficiency
• Bahamas on a budget -- $400 – 3 days in a tent – Willing to pay $550
• Midrange trip -- $600 – 4 days in the airport Motel 6 – Willing to pay $900
• Luxury trip -- $850 – 5 days in beachside hotel – Willing to pay $1100
• Ultra Luxury Weeklong trip -- $1250 – 7 days in a deluxe waterfront cabana – Willing to pay $1250
Net Benefits = $0
Net Benefits = $250
Net Benefits = $300
Net Benefits = $150
Economic Efficiency
• Bahamas on a budget -- $400 – 3 days in a tent – Willing to pay $550
• Midrange trip -- $600 – 4 days in the airport Motel 6 – Willing to pay $900
• Luxury trip -- $850 – 5 days in beachside hotel – Willing to pay $1100
• Ultra Luxury Weeklong trip -- $1250 – 7 days in a deluxe waterfront cabana – Willing to pay $1250
Net Benefits = $300
Net Benefits = $150
Economic Efficiency
• Bahamas on a budget -- $400 – 3 days in a tent – Willing to pay $550
• Midrange trip -- $600 – 4 days in the airport Motel 6 – Willing to pay $900
• Luxury trip -- $850 – 5 days in beachside hotel – Willing to pay $1100
• Ultra Luxury Weeklong trip -- $1250 – 7 days in a deluxe waterfront cabana – Willing to pay $1250
Net Benefits = $300
Net Benefits = $150
You value this trip $150 less
Economic Efficiency
• Bahamas on a budget -- $400 – 3 days in a tent – Willing to pay $550
• Midrange trip -- $600 – 4 days in the airport Motel 6 – Willing to pay $900
• Luxury trip -- $850 – 5 days in beachside hotel – Willing to pay $1100
• Ultra Luxury Weeklong trip -- $1250 – 7 days in a deluxe waterfront cabana – Willing to pay $1250
Net Benefits = $300
Net Benefits = $150
You value this trip $150 less BUT YOU SAVE
$400
Economic Efficiency
• Bahamas on a budget -- $400 – 3 days in a tent – Willing to pay $550
• Midrange trip -- $600 – 4 days in the airport Motel 6 – Willing to pay $900
• Luxury trip -- $850 – 5 days in beachside hotel – Willing to pay $1100
• Ultra Luxury Weeklong trip -- $1250 – 7 days in a deluxe waterfront cabana – Willing to pay $1250
Net Benefits = $0
Net Benefits = $150
Economic Efficiency
• Bahamas on a budget -- $400 – 3 days in a tent – Willing to pay $550
• Midrange trip -- $600 – 4 days in the airport Motel 6 – Willing to pay $900
• Luxury trip -- $850 – 5 days in beachside hotel – Willing to pay $1100
• Ultra Luxury Weeklong trip -- $1250 – 7 days in a deluxe waterfront cabana – Willing to pay $1250
Net Benefits = $0
Net Benefits = $150
You value this trip $200 less BUT YOU SAVE
$250
Economic Efficiency
• Bahamas on a budget -- $400 – 3 days in a tent – Willing to pay $550
• Midrange trip -- $600 – 4 days in the airport Motel 6 – Willing to pay $900
• Luxury trip -- $850 – 5 days in beachside hotel – Willing to pay $1100
• Ultra Luxury Weeklong trip -- $1250 – 7 days in a deluxe waterfront cabana – Willing to pay $1250
Net Benefits = $0
You value this trip $350 less BUT YOU SAVE
ONLY $200
