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Lecture03

# Lecture03 - Lecture 3 Consumer Choice Perlo Chapter 3...

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Lecture 3: Consumer Choice Perlo/ Chapter 3 Vladimir Petkov VUW 08 March 2009 Vladimir Petkov (VUW) Lecture 3: Consumer Choice 08 March 2009 1 / 26

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Budget Constraint Suppose that we cannot borrow or save. Then we cannot spend more than our income. Assume there are 2 goods, q 1 and q 2 , with prices p 1 and p 2 , respectively. The available income is Y . The set of bundles we can buy is de°ned by p 1 q 1 + p 2 q 2 6 Y q 1 > 0, q 2 > 0 . The constraint p 1 q 1 + p 2 q 2 6 Y is known as the budget constraint . The line with equation p 1 q 1 + p 2 q 2 = Y is known as the budget line . The set of a/ordable bundles is called the feasible set (or the opportunity set). Vladimir Petkov (VUW) Lecture 3: Consumer Choice 08 March 2009 2 / 26
Budget Constraint (Continued) Imagine that p 1 = \$1, p 2 = \$2, Y = \$500 . The graph below illustrates the opportunity set. Vladimir Petkov (VUW) Lecture 3: Consumer Choice 08 March 2009 3 / 26

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Budget Constraint (Continued) We can rewrite the budget line as q 2 = ( Y ° p 1 q 1 ) / p 2 . Thus, the slope of the budget line is ° p 1 / p 2 . The vertical intercept (at q 1 = 0 ) is Y / p 2 . The horizontal intercept (at q 2 = 0 ) is Y / p 1 . q 1 q 2 2 p Y 1 p Y Slope is 2 1 1 2 p p dq dq - = Budget line equation is 1 2 1 2 2 q P p p Y q - = Vladimir Petkov (VUW) Lecture 3: Consumer Choice 08 March 2009 4 / 26