Lecture_01_Budget_Constraints - Lecture 1: Budget...

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Unformatted text preview: Lecture 1: Budget Constraints c & 2008 Je/rey A. Miron Outline 1. Introduction 2. Two Goods are Often Enough 3. Properties of the Budget Set 4. How the Budget Line Changes 5. The Numeraire 6. Taxes, Subsidies, Rationing 1 Introduction Our development of economic theory has two main parts, consumers and producers. We will start with the consumers. We want to develop a model of consumer behavior that makes speci&c predictions about what goods consumers buy, how much, when, what factors determine this, and so on. This will allow us to analyze how consumers react in various situations (in re- sponse to di/erent kinds of information or goods, government policies, &rm advertis- ing). We start with the most basic component of the model: the budget constraint. This should mainly be review, with little new or hard material. I include it for completeness, to make sure were all using the same ideas and notations. Plus, we will add a few wrinkles relative to what you have seen. The basic framework is the following: at any point in time, a consumer can choose from a particular set of goods. For now, we will deal with exactly two goods, but this is mainly for exposition. 1 The consumer will end up, after the choice is made, with a particular consumption bundle. Call this ( x 1 ; x 2 ) It is always important to be clear about the units of measurement. There are many instances where the answer to an economics question is entirely about getting the units right. Also, it always helps to know exactly what we are measuring. In particular, we may be measuring physical units versus monetary units (like dollars), real versus nominal, etc. So, in this case, we measure goods 1 and 2 in terms of physical units: loaves of bread; minutes of cell phone use; gallons of water, number of cd&s; rounds of golf; etc. Say each good has some price at which the consumer can purchase the good. Denote these by ( p 1 ; p 2 ) These are the nominal prices, i.e., the sticker prices measured in, say, dollars. (This could be measured in some other units, not necessarily just currency. Ignore real versus nominal for the time being.) Then the consumer&s budget constraint is p 1 x 1 + p 2 x 2 & m where m is the amount of money the consumer has to spend. Again, think of m as measured in dollars. Thus, p 1 x 1 is expenditure on good 1 and p 2 x 2 is expenditure on good 2. The budget constraint simply says that total spending by the consumer must be less than or equal to the amount of money the consumer has to spend. Combinations of ( x 1 ; x 2 ) that satisfy this budget constraint are sometimes referred to as a/ordable consumption bundles . The set of a/ordable consumption bundles at a given set of prices and income is the budget set ....
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Lecture_01_Budget_Constraints - Lecture 1: Budget...

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