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Intermediate Microeconomics

Intermediate Microeconomics. Budget Sets. Consumer Theory. Consumer Theory - a model to describe how individuals behave. How do individuals choose what to consume? How do these decisions respond to changes in the environment? How should we proceed?. Budget Sets.

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Intermediate Microeconomics

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  1. Intermediate Microeconomics Budget Sets

  2. Consumer Theory • Consumer Theory - a model to describe how individuals behave. • How do individuals choose what to consume? • How do these decisions respond to changes in the environment? • How should we proceed?

  3. Budget Sets • What is the cost of purchasing another CD?

  4. Budget Set • Consumption Bundle – A list of numbers indicating how much of each good an individual is consuming: {q1, q2, …., qn} • Ex: Suppose there are two goods, pizza a beer. • {5,3} is a consumption bundle containing 5 slices of pizza and 3 beers. • {20,1} is a consumption bundle containing 20 slices of pizza and 1 beer. • Budget Set – the set of consumption bundles of goods a person can afford. • What does an individual’s Budget Set depend on?

  5. Budget Set • Suppose you are endowed with $24 (i.e. m = 24) and only goods you consume are pizza and beer. • Pizza costs $2/slice (i.e. pp = 2) • Beers cost $4/each (i.e. pb = 4) • How can we fully describe your budget set? • Analytically? • Graphically? • What if you lived in London and had £12 and Pizza cost £1/slice and Beers cost £2 each?

  6. Graphing Budget Sets • Slope of budget constraint is simply negative of price ratio (-p1/p2) at that point. • How do we interpret this? q2 1 m/p2 -p1/p2 q1 m/p1

  7. Graphing Budget Sets • What happens when prices change? • m = 24, pp = 4 and pb = 8 • m = 24, pp = 4, and pb = 4 • m = 24, pp = 2 and pb = 6

  8. Graphing Budget Sets • What happens when endowment changes but prices don’t? • m = 40, pp = 2, and pb = 4 • m = 16, pp = 2 and pb = 4

  9. Budget Sets and Taxes • Suppose m = $24, pp = 2, and pb = 4 • How would budget set change if a 50% sales tax were imposed on beer? • How about if a 50% sales tax were imposed on all goods? • How about if pizza was subsidized (i.e. CMC paid half the price of each slice)?

  10. Is two-good framework sufficient? • Suppose we are interested in analyzing good 1, but there are two other goods that a consumer can also spend money on. • Analyze good 1 compared to a composite good which is just the amount of money spent on all other goods (i.e. goods 2 and 3). • Denoting “dollars” of composite good as qc we can write budget set as: • qc + p1q1≤ m • p2q2 + p3q3≤ qc • If we are only interested in analyzing good 1, we can ignore equation 2, and we are back in two-good framework. • How would we draw this? What is slope?

  11. More Complicated Budget Constraints • Budget constraints seem pretty simple, why do we make them so complicated? • Consider more complicated pricing schemes. • Quotas. • Bulk Pricing

  12. More Complicated Budget Constraints • Government policy can also often make budget constraints more complicated • Food Stamps • pre-1979 – qualifying “poor” households could “buy” up to $200 worth of food stamps/month at a rate of $1 worth of food stamps for $0.50. • post-1979 - qualifying “poor” households given $100 in food stamps. • How do budget sets differ across two programs for a person earning $300/mo.?

  13. More Complicated Budget Constraints • Public housing • Suppose a person is given a take-it-or-leave-it offer of a free apartment • Further suppose this apartment would rent for $300/month in the marketplace. • If person had $300/mo. in income, what would budget constraint look like? • What if instead of this in-kind benefit, person was given $300 in cash. • What would budget constraint look like? • So why don’t we always give cash benefits?

  14. Budget Constraints more broadly • Goods and endowments can be thought of more broadly. • Ex. Suppose you work for the Doctors Without Borders. • Budget: $10,000/mo. • Each AIDS patient you treat costs $1000/mo. • Each Tuberculosis patient costs $500/mo. • What is your budget set? What does slope tell us? • What happens if the drug company who makes the AIDS drugs drops their price to $500/mo. for each treatment you buy in excess of 5?

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