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3_Budgets_Choice

3_Budgets_Choice - 3 BUDGETS CHOICE Rubinfeld Pindyck 3.2...

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3. BUDGETS & CHOICE Rubinfeld & Pindyck 3.2, 3.3
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Budget constraint The budget constraint is a straight line. The points on the line, and below the line (in the positive d ) h b d quadrant) are the budget set. The equation of the budget constraint: P p p + P e e = I / / p = I/P p – (P e /P p )e Question: could the budget constraint be a kinked line?
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Changes to budget constraints If income changes but prices stay constant, the budget constraint shifts in parallel direction.
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Changes to budget constraints If income stays constant but prices change, it rotates.
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Consumer Choice How do you choose which bundle to buy? Ones that you cannot afford are eliminated. But your budget set still has more than 1 bundle. What rule do you use? Economists make the assumption that people try to get the most value for their money. In other words, maximize your satisfaction, subject to your budget constraint.
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Choosing your bundle… in economics lingo The consumer wants to achieve the highest IC.
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