recall slope of budg

# recall slope of budg - Recall Slope of Budget Constraint...

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1 Recall: Slope of Budget Constraint • Slope = p1/p2 (relative price) • The slope of the line is the opportunity cost of good 1 (x-axis good) in terms of good 2 (y-axis good) how much good 2 you would have to give up to get one more of good 1 – two bo staffs for 1 nunchuk p1/p2: how much q2 you have to give up to get 1 more q1 • To ‘buy’ one more unit of good 1, we need p 1 dollars. We can ‘sell’ units of good 2 to get dollars at p 2 each. So to get p 1 dollars we would need to ‘sell’ (give up) p 1 /p 2 of good 2. – To get one more nunchuk we need p1=\$2. We can “sell” bo staffs for p2=\$1 each. To get enough \$ we would have to sell 2 bo staffs (p1/p2).

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2 Recall: Slope of Indifference Curve • Marginal Rate of Substitution (MRS) • MRS is the amount of the good on the y-axis the consumer is willing to give up to compensate for the gain of 1 unit of the good on the x-axis. • The MRS at any point along an indifference curve is the absolute value of the slope of the indifference curve at that point. q 2 q 1 Slope = MRS = q 2 / q 1 q 2 q 1
3 Putting it all together: constrained optimization I/p 2 I/p 1 q 2 q 1 Optimality condition: p1/p2 = MRS • MRS: willingness to give up good 2 to get good 1… amount of good 2 you’re willing to give up to get one more good 1 • p1/p2: opportunity cost of good 1 in terms of good 2… how much good 2 you have to give up to get one more of good 1

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4 Optimality condition: p1/p2 = MRS • what if MRS > p1/p2? – at a point where IC is steeper than BC – MRS how much good 2 you are willing to give up for good 1 is MORE than p1/p2 how much good 2 you have to give up for good 1 • you’re willing to give up more good 2 for good 1 than you would have to based on relative prices – so more good 1, less good 2, would make you better off MRS=p1/p2 I/p 2 I/p 1 q 2 q 1
Constructing the Demand curve • The Demand curve traces out quantity demanded vs. price. So we can use the budget line / indifference curve framework to generate the price, quantity pairs… Constructing the Demand curve q1 q1

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recall slope of budg - Recall Slope of Budget Constraint...

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