Intermediate Microeconomics

1
Intermediate Microeconomics

• Budget Sets

2
Consumer Theory

• First part of class we want to understand
  demand.
• We want to do so from first principles.
• 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 can we use this model to describe market
  demand for goods?
• How should we start?

3
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, peanuts and
  beer.
• 5,12 is a consumption bundle containing 5 oz.
  of peanuts and 12 oz of beer.
• 20,6 is a consumption bundle containing 20 oz
  of peanuts and 6 oz of beer.
• Budget Set the set of consumption bundles of
  goods a person can afford.
• What does an individuals Budget Set depend on?

4
Budget Set

• Suppose you are endowed with 10 (i.e. m 10)
  and only goods you consume are peanuts and beer.
• Peanuts cost 0.10/oz (i.e. pp 0.10)
• Beer costs 0.20/oz (i.e. pb 0.20)
• How can we fully describe your budget set?
• Analytically?
• Graphically?

5
Budget Set

• Interpreting prices
• As we will see, prices will play a big role in
  our analysis of consumer behavior.
• How would we describe the price of an ounce of
  beer intuitively?
• So what would slope of budget set look like if
  you lived in London, were endowed with 5 pounds,
  and where
• Peanuts cost 0.5 pence/oz
• Beer costs 0.10 pence/oz

6
Graphing Budget Sets

• Slope of budget constraint is rise/run or simply
  negative of price ratio (-p1/p2).
• So how do we interpret this slope?

q2
m/p2
1
-p1/p2
q1
m/p1
7
Graphing Budget Sets

• What happens when relative prices change?
• (original) m 10, pp 0.10 and pb 0.20
• m 10, pp 0.20, and pb 0.20
• m 10, pp 0.10 and pb 0.10

8
Graphing Budget Sets

• What happens when endowment changes but relative
  prices dont?
• (original) m 10, pp 0.10 and pb 0.20
• m 20, pp 0.10, and pb 0.20
• m 4, pp 0.10 and pb 0.20

9
Budget Sets and Taxes

• Suppose m 10, pp 0.10, and pb 0.20
• How would budget set change if a 25 sales tax
  were imposed on beer?
• How about if a 25 sales tax were imposed on all
  goods?
• How about if a 25 tax were imposed on each
  persons endowment?

10
Is two-good framework sufficient?

• With two goods, we could write a budget set as
• p1q1 p2q2 m
• 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.
• Bulk Pricing
• Hamburger is 2/lb for first 3lbs, but only 1/lb
  for each additional amount past 3lbs.

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 500/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 dont we always give cash benefits?

14
Budget Constraints more broadly

• Suppose you worked for Doctors without Borders.
• Your funds are enough to have twenty beds in
  your clinic.
• Each malaria patient you treat needs one week in
  your clinic for full treatment.
• Each tuberculosis patient you treat needs two
  weeks in your clinic for full treatment.
• What is monthly budget constraint? What is the
  cost/price of treating a tuberculosis patient?