Budget Constraint Lecture Notes Sep27

Budget Constraint Lecture Notes Sep27 - Which means it...

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Budget Constraint 1. Two Goods 2. Properties 3. Changes in BL 4. Numeraire (Skip) 5. Taxes, Subsidies, and Rationing 1. Two Goods Income=m Price 1 and Price 2 = P1 and P2 Quantities = X1 and X2 Money spent on item 1 = P1X1 Money spent on item 2 = P2X2 BC is m P1X1+P2X2 2. Properties Budget Line: m=P1X1+P2X2 IF all money goes to P1: (m/P1, 0) IF all money goes to P2: (0, m/P2) The connection of these two plotted points will create the Budget Line. Slope of budget line is the opportunity cost/ratio of prices Slope = -P1/P2 Suppose you want to consume more of X1 but m, P1, P2 don’t change. Proof that slope is opportunity cost: P1(X1+ Δ X1) + P2(X2+ Δ X2)=m - (P1X1+P2X2=m) = P1 Δ X1 + P2 Δ X2=0 Δ X1/ Δ X2 = -P1/P2 3. Changes in BL What if m increases? m turns into m’ and m’ > m Then the intercepts on the BL will increase Suppose now that P1 increases. P1’ > P1 Then the x-intercept will decrease or shift to the left. Suppose both prices increase tP1, tP2 m=tP1X1+tP2X2 m/t=P1X1+P2X2
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Unformatted text preview: Which means it would be the same as dividing your income by the factor of price increase. 5. Taxes, Subsidies, and Rationing Two types of Taxes & Subsidies, quantity and value. Taxes: Quantity = P = P+t Value= P = P(1+) = percentage of tax Subsidies: Quantity = P = P-S Value = P = P(1-) =percentage of subsidy Lump-Sum: m+l (subsidy) m-l (tax) Rationing: Refer to graph in book. Examples ticketmaster ticket purchase limit or iphone purchase limits Review Question 6: P1X1+P2X2=m 1. L-S Tax of u 2. Quantity tax t for good 1 3. Quantity subsidy s for good 2 (P1+t)X1+(P2-s)X2=m-u Intercepts: m/P1 > m-u/P1+t ; m/P2 ? m-u/P2-s Slope: -P1/P2 < -P1+t/P2-s in absolute value Review Question 7: m increases P1 decreases P2 stays the same Are you at least well off? Yes because the budget line goes outward and the slope will decrease or become less steep thus increasing affordability....
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Budget Constraint Lecture Notes Sep27 - Which means it...

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