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Chapter 2 3 - Chapter Two Budgetary and Other Constraints...

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Chapter Two Budgetary and Other Constraints on Choice
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Consumption Choice Sets A consumption choice set is the collection of all consumption choices available to the consumer. What constrains consumption choice? Budgetary, time and other resource limitations.
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Budget Constraints A consumption bundle containing x 1 units of commodity 1, and x 2 units of commodity 2 is denoted by the vector (x 1 , x 2 ). Commodity prices are p 1 , p 2
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Budget Constraints Q: When is a consumption bundle (x 1 , x 2 ) affordable at given prices p 1 , p 2 ? When p 1 x 1 + p 2 x 2 m where m is the consumer’s (disposable) income.
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Budget Constraints The bundles that are only just affordable form the consumer’s budget constraint. This is the set { (x 1 , x 2 ) | such that p 1 x 1 + p 2 x 2 = m }. The budget constraint is the upper boundary of the budget set
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Budget Set and Constraint for Two Commodities x 2 x 1 Budget constraint is p 1 x 1 + p 2 x 2 = m. m /p 2 m /p 1
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Budget Set and Constraint for Two Commodities x 2 x 1 Budget constraint is p 1 x 1 + p 2 x 2 = m. m /p 1 Just affordable m /p 2
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Budget Set and Constraint for Two Commodities x 2 x 1 Budget constraint is p 1 x 1 + p 2 x 2 = m. m /p 1 Just affordable Not affordable m /p 2
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Budget Set and Constraint for Two Commodities x 2 x 1 Budget constraint is p 1 x 1 + p 2 x 2 = m. m /p 1 Affordable Just affordable Not affordable m /p 2
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Budget Set and Constraint for Two Commodities x 2 x 1 Budget constraint is p 1 x 1 + p 2 x 2 = m. m /p 1 Budget Set the collection of all affordable bundles. m /p 2
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Budget Set and Constraint for Two Commodities x 2 x 1 p 1 x 1 + p 2 x 2 = m is x 2 = -(p 1 /p 2 )x 1 + m /p 2 so slope is -p 1 /p 2 . m /p 1 Budget Set m /p 2
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Budget Constraints For n = 2 and x 1 on the horizontal axis, the constraint’s slope is -p 1 /p 2 . What does it mean? Increasing x 1 by 1 must reduce x 2 by p 1 / p 2. 1 2 1 2 2 p m x x p p =- +
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Budget Constraints x 2 x 1 Slope is -p 1 /p 2 +1 -p 1 /p 2
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Budget Constraints x 2 x 1 +1 -p 1 /p 2 Opp. cost of an extra unit of commodity 1 is p 1 /p 2 units foregone of commodity 2.
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Budget Constraints x 2 x 1 Opp. cost of an extra unit of commodity 1 is p 1 /p 2 units foregone of commodity 2. And the opp. cost of an extra unit of commodity 2 is p 2 /p 1 units foregone of commodity 1. -p 2 /p 1 +1
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Budget Sets & Constraints; Income and Price Changes The budget constraint and budget set depend upon prices and income. What happens as prices or income change?
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How do the budget set and budget constraint change as income m increases? Original budget set x 2 x 1
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Higher income gives more choice Original budget set New affordable consumption choices x 2 x 1 Original and new budget constraints are parallel (same slope).
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How do the budget set and budget constraint change as income m decreases?
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