# ch04 - Chapter4 Consumer Choice 1 ChapterFourOverview...

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Chapter 4 Consumer Choice 1

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Chapter Four Overview 1 The Budget Constraint 1. The Budget Constraint 2. Consumer Choice 3. Duality 4. Some Applications 5 Revealed Preference 5. Revealed Preference 2 Chapter Four
Key Definitions Budget Set: • The set of baskets that are affordable Budget Constraint: •The set of baskets that the consumer may The set of baskets that the consumer may purchase given the limits of the available income. Budget Line: • The set of baskets that one can purchase when spending all available income. P x X + P y Y = I 3 Y = I/P y – (P x /P y )X Chapter Four

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The Budget Constraint Assume only two goods available: X and Y • Price of x: P x ; Price of y: P y • Income: I Income: Total expenditure on basket (X,Y): P x X + P y Y The Basket is Affordable if total expenditure does not exceed total Income: P X X + P Y Y I 4 Chapter Four
A Budget Constraint Example Two goods available: X and Y I = \$10 P \$1 x = \$1 P y = \$2 ll / All income spent on X I/P x units of X bought Budget Line 1: 1X + 2Y = 10 Or All income spent on Y I/P y units of X bought Y = 5 – X/2 Slope of Budget Line = P x /P y = 1/2 5 Chapter Four

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A Budget Constraint Example Y A I/P Y = 5 Budget line = BL 1 C B P X /P Y = 1/2 6 I/P X = 10 X Chapter Four
Budget Constraint Location of budget line shows what the income level is. Increase in Income will shift the budget line to the right. M f h d t b ff d bl More of each product becomes affordable Decrease in Income will shift the budget line h l f to the left. less of each product becomes affordable 7 Chapter Four

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A Budget Constraint Example Y I = \$12 P \$1 Shift of a budget line X = \$1 P Y = \$2 If income rises, the budget line shifts parallel to the right (shifts out) 5 6 Y = 6 X/2 …. BL 2 If income falls, the budget line shifts parallel to the left (shifts in) BL 2 BL 1 8 X 10 12 Chapter Four
Budget Constraint Location of budget line shows what the income level is.

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