PowerPoint PresentationSlide 2Slide 3Slide 4Slide 5Slide 6Slide 7Slide 8Slide 9Slide 10Slide 11Slide 12Slide 13Slide 14Slide 15Slide 16Slide 17Slide 18Slide 19Slide 20Slide 21Slide 22Slide 23Slide 24Slide 25Slide 26Slide 27Slide 28Slide 29Slide 30Slide 31Slide 32Slide 33Slide 34Slide 35Slide 36Slide 37Slide 38Slide 39Slide 40Slide 41The Consumer Problem and the Budget ConstraintOverheadsThe fundamental unit of analysisin consumption economics is the individual consumerThe underlying assumption in consumption analysis is that all consumers possess a preference orderingwhich allows them to rank alternative states of the world.The behavioral assumption in consumption analysis is that consumers make choices consistent with their underlying preferencesThe main constraint facing consumersin determining which goodsto purchase and consume isThis is called the budget constraint the amount of income that they can spendThe Consumer ProblemThe consumer problem is to maximizethe consumer has to spend. the satisfaction that comes from theconsumption of various goodssubject to the amount of incomeThe Consumer ProblemMaximizesatisfactionsubject toincomeDefinition of the budget constraintA consumer’s budget constraint identifies which combinations of goods and servicesthe consumer can afford with a limited budget, at given pricesNotationIncome - IQuantities of goods - q1, q2, . . . qnPrices of goods - p1, p2,. . . pnNumber of goods - nBudget constraint with 2 goodsp1q1 p2q2 Ip1q1 p2q2 p3q3 pnqn IBudget constraint with n goodsExampleIncome = I = $1.20q1 = Reese’s Piecesp1 = price of Reese’s Pieces = $0.30q2 = Snickersp2 = price of Snickers = $0.20Graphical Analysis of Budget Set0123450 1 2 3 4 5 6 7SnickersReese’sGraphical Analysis of Budget Set0123450 1 2 3 4 5 6 7q2q1Graphical Analysis of Budget Set0123450 1 2 3 4 5 6 7q2q14 Reese’s -- 0 Snickers Cost = 4 x 0.30 + 0 x 0.20 = $1.20Graphical Analysis of Budget Set0123450 1 2 3 4 5 6 7q2q10 Reese’s -- 6 Snickers Cost = 0 x 0.30 + 6 x 0.20 = $1.20Graphical Analysis of Budget Set0123450 1 2 3 4 5 6 7q2q12 Reese’s -- 3 Snickers Cost = 2 x 0.30 + 3 x 0.20 = $1.20Graphical Analysis of Budget Set0123450 1 2 3 4 5 6 7q2q12 Reese’s -- 1 Snickers Cost = 2 x 0.30 + 1 x 0.20 = $.80Graphical Analysis of Budget Set0123450 1 2 3 4 5 6 7q2q13 Reese’s -- 3 Snickers Cost = 3 x 0.30 + 3 x 0.20 = $1.50Graphical Analysis of Budget Set0123450 1 2 3 4 5 6 7q2q1There are many different combinationsOnly some combinations are feasibleGraphical Analysis of Budget Set0123450 1 2 3 4 5 6 7q2q1Some combinations exactly exhaust incomeGraphical Analysis of Budget Set0123450 1 2 3 4 5 6 7q2q1We say these points lie along the budget lineGraphical Analysis of Budget Set0123450 1 2 3 4 5 6 7q2q1Or on the boundary of the budget setGraphical Analysis of Budget Set0123450 1 2 3 4 5 6 7q2q1Points inside or on the line are affordableGraphical Analysis of Budget SetBudget Set0123450 1 2 3 4 5 6 7q2q1Points outside the line are not affordableSlope of the Budget Constraint - q1 = h(q2)p1q1 p2q2 I p1q1 I p2q2 q1Ip1 p2p1q2So the slope is -p2 / p1Graphical Analysis of Budget Set0123450 1 2 3 4 5 6 7q2q10 Snickers -- 4 Reese’sq2 = - 33 Snickers -- 2 Reese’s q1q1 = 2Δq1Δq22 3 23Graphical Analysis of Budget Set0123450 1 2 3 4 5 6 7q2q10 Snickers -- 4 Reese’s3 Snickers -- 2 Reese’s q1 = 2Δq1Δq22 3 23 p2p1 0.200.30q2 = - 3Numerical ExampleI = $1.20, p1 = 0.30, p2 = 0.200.30q1 0.20q2 1.20 0.30q1 1.20 0.20q2 q11.200.30 0.200.30q2 4 23q215 6 743212345Budget Constraint - 0.3q1 + 0.2q2 = $1.20AffordableNot Affordableq1q2q1 4 23q20.3q1 1.2 0.2q215 6 743212345Budget Constraint - 0.3q1 + 0.2q2 = $1.20AffordableNot Affordableq2q1Double prices and incomeDouble prices and incomeq1 4 23q2Budget Constraint - 0.6q1 + 0.4q2 = $2.400.6q1 2.4 0.4q215 6 743212345Budget Constraint - 0.6q1 + 0.2q2 = $1.20Affordableq2q1Not AffordableDouble pDouble p11 from 0.3 to 0.6 from 0.3 to 0.6q1 2 13q2Budget Constraint - 0.3q1 + 0.2q2 = $1.200.6q1 1.2 0.2q2Just to review how to solveBudget Constraint - 0.6q1 + 0.2q2 = $1.20 0.60q1 1.20 0.20q2 q11.200.600.200.60q2 q1 2 13q215 6 743212345Budget Constraint - 0.3q1 + 0.3q2 = $1.20Affordableq2q1Raise pRaise p22 from 0.2 to 0.3 from 0.2 to 0.3Not Affordableq1 4 q2Budget Constraint - 0.3q1 + 0.2q2 = $1.200.3q1 1.2 0.3q215 6 743212345q1q2Change in IncomeBudget Constraint0 - 0.3q1 + 0.2q2 = $1.20Budget Constraint1 - 0.3q1 + 0.2q2 = $0.60q1 2 23q20.3q1 0.6 0.2q2Change in Price of Good 1 (price rises)Budget Constraint0 - 0.3q1 + 0.2q2 = $1.2015 6 743212345q1q2Budget Constraint1 - 0.6q1 + 0.2q2 = $1.20Change in Price of Good 1 (price falls)Budget Constraint0 - 0.3q1 + 0.2q2 = $1.20Budget Constraint1 - 0.24q1 + 0.2q2 = $1.2015 6 743212345q1q2Change in Price of Good 2 (price rises)Budget Constraint0 - 0.3q1 + 0.2q2 = $1.20Budget Constraint1 - 0.30q1 + 0.30q2 = $1.2015 6 743212345q1q2The EndGraphical Analysis of Budget SetBudget Set0123450 1 2 3 4 5 6 7q2q1Graphical Analysis of Budget SetBudget Set0123450 1 2 3 4 5 6
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