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University of Hawai‘i at Mānoa Department of Economics

University of Hawai‘i at Mānoa Department of Economics. ECON 130 (003): Principles of Economics (Micro) http://www2.hawaii.edu/~lindoj Gerard Russo Lecture #11 Tuesday, February 17, 2004. LECTURE 11. Revealed Preference Budget Lines. Consumer Theory. Consumer Choice

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University of Hawai‘i at Mānoa Department of Economics

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  1. University of Hawai‘i at MānoaDepartment of Economics ECON 130 (003): Principles of Economics (Micro) http://www2.hawaii.edu/~lindoj Gerard Russo Lecture #11 Tuesday, February 17, 2004

  2. LECTURE 11 • Revealed Preference • Budget Lines

  3. Consumer Theory • Consumer Choice • Consumers select bundles of consumption goods given their Preferences and subject to their budget constraint. • Consumer preferences over goods and services are represented by a utility function, U(x,y). • Budget Constraint: PXX + PYY ≤ B.

  4. A Simple Model of a Consumer Budget • 2 goods • Good x (i.e., soft drink) • Good y (i.e., pizza) • 2 Prices • Price of good x, Px • Price of good y, Py • Fixed Income or Budget, B

  5. The Consumer Budget Constraint • Total expenditures on goods x and y cannot exceed the consumer’s income (consumer’s budget). • Expenditures on good x = Pxx. • Expenditures on good y = Pyy. • Total Expenditures = Pxx + Pyy. • Total expenditures must be less than or equal to the consumer’s budget. • Pxx + Pyy ≤ B.

  6. The Consumer’s Budget Set • The Consumer’s budget set is the set of consumption bundles composed of goods x and y such that total expenditures are less than or equal to the consumer’s budget. • Budget Set = { (x,y) | Pxx + Pyy ≤ B } .

  7. The Consumer’s Budget Line • Pxx + Pyy = B • Isolate y: y = B/Py – (Px/Py)x • The y intercept = B/Py • The slope = ∆y/ ∆ x = - (Px/Py) • Isolate x: x = B/Px – (Py/Px)y • The x intercept = B/Px • The slope = ∆x/ ∆ y = - (Py/Px)

  8. Quantity of Good y Budget Line: y = B/Py – (Px/Py)x B/Py Slope = ∆ y/ ∆x = - Px/Py B/Px Quantity of Good x

  9. Budget Line: An Example • Price of good y = $2 per unit • Price of good x = $1 per unit • Budget = $100 • $1x + $2y = $100 • y = 50 – 0.5x • x = 100 – 2y

  10. Quantity of Good y Budget Line: y = B/Py – (Px/Py)x y = 50 – 0.5 x B/Py =$100/$2 =50 Slope = ∆ y/∆x = - Px/Py = -$1/$2 B/Px = $100/$1 = 100 Quantity of Good x

  11. Quantity of Good y Budget Set ={ (x,y) | Pxx +Pyy ≤ B} B/Py Budget Set B/Px Quantity of Good x

  12. Quantity of Good y Income Increases B/Py B/Py Slope = - Px/Py B/Px B/Px Quantity of Good x

  13. Quantity of Good y Income Decreases B/Py Slope = - Px/Py B/Py B/Px B/Px Quantity of Good x

  14. Quantity of Good y Price of Good x Increases B/Py Slope = - Px/Py Slope = - Px/Py B/Px B/Px Quantity of Good x

  15. Quantity of Good y Price of Good x Decreases B/Py Slope = - Px/Py Slope = - Px/Py B/Px B/Px Quantity of Good x

  16. Quantity of Good y Price of Good y Increases B/Py Slope = - Px/Py B/Py Slope = - Px/Py B/Px Quantity of Good x

  17. Quantity of Good y Price of Good y Decreases Slope = - Px/Py B/Py B/Py Slope = - Px/Py B/Px Quantity of Good x

  18. Quantity of Good y What happens if income doubles and prices double? B/Py Slope = - Px/Py B/Px Quantity of Good x

  19. Quantity of Good y •W •Z •R •N •A •V •L •O •M Quantity of Good x

  20. Quantity of Good y Point A is dominated by points in this set. •A Point A dominates points in this set. Quantity of Good x

  21. Assumptions about Consumers • Consumers are rational. • Consumers prefer more to less. • Nonsatiation • Preferences (tastes) are stable. • Choice vs. Preference

  22. Quantity of Good y Is A preferred to Z? Or, is Z preferred to A? Is A preferred to L? Or, is L preferred to A? Is A preferred to R? Or, is R preferred to A? Is A preferred to O? Or, is O preferred to A? •R •Z •A •L •O Quantity of Good x

  23. Quantity of Good y Consumer Choice: Year 2003 •Z •V Consumption Bundle A is Revealed Preferred to R, O, M, etc. •R •A •O •L •M Budget Line: Year 2003 Quantity of Good x

  24. Suppose the consumer chooses consumption bundle A in the year 2003. Quantity of Good y •A Budget Line: Year 2003 Quantity of Good x

  25. Is the consumer better off or worse off in 2004? Quantity of Good y Are goods x and y normal or inferior? •W Budget Line: Year 2004 •R •A •L 0 Budget Line: Year 2003 Quantity of Good x

  26. Is the consumer better off or worse off in 2004? Quantity of Good y Are goods x and y normal or inferior? Budget Line: Year 2003 •W •A •R •L 0 Budget Line: Year 2004 Quantity of Good x

  27. Is the consumer better off or worse off in 2004? Quantity of Good y •M Budget Line: Year 2004 •W •A •L 0 Budget Line: Year 2003 Quantity of Good x

  28. Quantity of Good y Is the consumer better off or worse off in 2004? •L Budget Line: Year 2004 •J •A •R •W 0 Budget Line: Year 2003 Quantity of Good x

  29. Is the consumer better off or worse off in 2004? Quantity of Good y Budget Line: Year 2004 •M •A •L •J 0 Budget Line: Year 2003 Quantity of Good x

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