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Questions and Answers
What does the budget line represent in a microeconomic context?
What does the budget line represent in a microeconomic context?
- The set of bundles that cost less than m
- The maximum consumption of good 1 only
- The set of bundles that cost exactly m (correct)
- The minimum consumption necessary to meet m
What does the slope of the budget line indicate?
What does the slope of the budget line indicate?
- The overall market demand for good 1
- The opportunity cost of consuming good 1 in terms of good 2 (correct)
- The vertical distance between goods 1 and 2
- The total consumption of both goods
How can the two intercepts of the budget line be determined?
How can the two intercepts of the budget line be determined?
- By setting p1 equal to m
- By averaging the prices of both goods
- By substituting x1 and x2 values into the budget equation
- By determining the maximum quantities of each good based on prices (correct)
How is the rate of substitution between good 1 and good 2 expressed mathematically?
How is the rate of substitution between good 1 and good 2 expressed mathematically?
When a consumer increases their consumption of good 1, what must occur to maintain the budget constraint?
When a consumer increases their consumption of good 1, what must occur to maintain the budget constraint?
What does the budget constraint equation represent?
What does the budget constraint equation represent?
In the context of the budget constraint, if p1 increases, what happens to the budget set?
In the context of the budget constraint, if p1 increases, what happens to the budget set?
How is good 2 defined in the two-good model?
How is good 2 defined in the two-good model?
If a consumer's income (m) increases, what is the immediate effect on the budget constraint?
If a consumer's income (m) increases, what is the immediate effect on the budget constraint?
Which statement about the budget constraint is true?
Which statement about the budget constraint is true?
In the equation $p_1x_1 + p_2x_2 \leq m$, what does the term $p_2x_2$ represent?
In the equation $p_1x_1 + p_2x_2 \leq m$, what does the term $p_2x_2$ represent?
Which of the following would decrease the set of affordable consumption bundles?
Which of the following would decrease the set of affordable consumption bundles?
If a consumer spends all their income on good 1, what can be inferred about their consumption of good 2?
If a consumer spends all their income on good 1, what can be inferred about their consumption of good 2?
What does the budget constraint formula represent?
What does the budget constraint formula represent?
How does increasing the income (m) affect the budget line?
How does increasing the income (m) affect the budget line?
What would happen if the price of good 1 (p1) increases?
What would happen if the price of good 1 (p1) increases?
When a consumer's consumption of good 1 (x1) is less than or equal to x̄1, what is the slope of the budget line?
When a consumer's consumption of good 1 (x1) is less than or equal to x̄1, what is the slope of the budget line?
What does it mean to assign one price a value of 1 in economic theory?
What does it mean to assign one price a value of 1 in economic theory?
In terms of budget lines, how does multiplying all prices by a factor t affect the budget line?
In terms of budget lines, how does multiplying all prices by a factor t affect the budget line?
What is represented by the vertical intercept of the budget line?
What is represented by the vertical intercept of the budget line?
What does the term 'budget set' refer to?
What does the term 'budget set' refer to?
What happens to the budget line if price 2 increases more than price 1?
What happens to the budget line if price 2 increases more than price 1?
What is the formula for the budget line if good 2 is pegged as the numeraire?
What is the formula for the budget line if good 2 is pegged as the numeraire?
How does a quantity tax affect the price of good 1?
How does a quantity tax affect the price of good 1?
If an ad valorem subsidy is applied, how is the price of good 1 affected?
If an ad valorem subsidy is applied, how is the price of good 1 affected?
When price 2 is set to 1, what do p1 and income m represent?
When price 2 is set to 1, what do p1 and income m represent?
What is the result of a value tax (ad valorem tax) on the budget line?
What is the result of a value tax (ad valorem tax) on the budget line?
How does a quantity subsidy influence the budget line?
How does a quantity subsidy influence the budget line?
What is the effect on the budget line if price 2 increases less than price 1?
What is the effect on the budget line if price 2 increases less than price 1?
What happens to the budget line when income increases from m to m0, where m0 > m?
What happens to the budget line when income increases from m to m0, where m0 > m?
When the price of good 1 increases while holding the price of good 2 and income fixed, what is expected to happen to the slope of the budget line?
When the price of good 1 increases while holding the price of good 2 and income fixed, what is expected to happen to the slope of the budget line?
If both prices (p1 and p2) increase by a factor of t where t > 1, what effect does this have on the budget line?
If both prices (p1 and p2) increase by a factor of t where t > 1, what effect does this have on the budget line?
What is the effect on the budget line when both prices and income decrease?
What is the effect on the budget line when both prices and income decrease?
When price p1 increases to p10, which equation represents the new budget line?
When price p1 increases to p10, which equation represents the new budget line?
What happens to the intercepts of the budget line when income decreases?
What happens to the intercepts of the budget line when income decreases?
If both prices and income simultaneously increase, what will be the overall impact on the budget line?
If both prices and income simultaneously increase, what will be the overall impact on the budget line?
In the equation of a budget line, which of the following best describes the meaning of 'mp2'?
In the equation of a budget line, which of the following best describes the meaning of 'mp2'?
If the budget constraint is represented by the equation $x2 = mp2 - p2 x1$, which variable shows the quantity consumed of good 1?
If the budget constraint is represented by the equation $x2 = mp2 - p2 x1$, which variable shows the quantity consumed of good 1?
From the changes in budget constraints, what is indicated by the notation 't < 1'?
From the changes in budget constraints, what is indicated by the notation 't < 1'?
Flashcards
Budget Constraint
Budget Constraint
The limit on the amount of goods a consumer can purchase given their income and prices.
Consumption Bundle (X)
Consumption Bundle (X)
The combination of goods a consumer chooses to buy, represented by X = (x1, x2) where x1 is the amount of good 1 and x2 is the amount of good 2.
Budget Constraint Equation
Budget Constraint Equation
p1x1 + p2x2 ≤ m, where p1 is the price of good 1, x1 is the amount of good 1, p2 is the price of good 2, x2 is the amount of good 2, and m is income. The equation states that the total amount spent on goods cannot exceed income.
Budget Set
Budget Set
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Budget Line
Budget Line
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Slope of the Budget Line
Slope of the Budget Line
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Opportunity Cost
Opportunity Cost
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Vertical Intercept of the Budget Line
Vertical Intercept of the Budget Line
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Horizontal Intercept of the Budget Line
Horizontal Intercept of the Budget Line
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Shifting the Budget Line: Income Increase
Shifting the Budget Line: Income Increase
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Shifting the Budget Line: Income Decrease
Shifting the Budget Line: Income Decrease
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Shifting the Budget Line: Price of Good 1 Increase
Shifting the Budget Line: Price of Good 1 Increase
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Shifting the Budget Line: Price of Good 1 Decrease
Shifting the Budget Line: Price of Good 1 Decrease
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Shifting the Budget Line: Price of Both Goods Increase (Proportional)
Shifting the Budget Line: Price of Both Goods Increase (Proportional)
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Shifting the Budget Line: Price of Both Goods Increase (Non-Proportional)
Shifting the Budget Line: Price of Both Goods Increase (Non-Proportional)
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Shifting the Budget Line: Price of Both Goods Decrease (Proportional)
Shifting the Budget Line: Price of Both Goods Decrease (Proportional)
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Numeraire
Numeraire
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Quantity Tax
Quantity Tax
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Value Tax (Ad Valorem Tax)
Value Tax (Ad Valorem Tax)
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Quantity Subsidy
Quantity Subsidy
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Value (Ad Valorem) Subsidy
Value (Ad Valorem) Subsidy
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Rationing
Rationing
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What is the relationship between the slope of the budget line and the opportunity cost of consuming good 1?
What is the relationship between the slope of the budget line and the opportunity cost of consuming good 1?
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How does a change in income affect the budget constraint?
How does a change in income affect the budget constraint?
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How does a change in the price of good 1 affect the budget constraint?
How does a change in the price of good 1 affect the budget constraint?
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Why is the Numeraire concept helpful?
Why is the Numeraire concept helpful?
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Study Notes
Consumer Theory
- Consumers choose the best bundle of goods they can afford
- The “best” bundle is the focus of the next chapter
- The “can afford” is the budget constraint
The Budget Constraint
- The consumer's consumption bundle of goods is X = (x1, x2)
- x1 is the amount of good 1 consumed
- x2 is the amount of good 2 consumed
- Prices are (p1, p2)
- p1 is the price of good 1
- p2 is the price of good 2
- The consumer's income is m
- The budget constraint equation is: p1x1 + p2x2 ≤ m
- p1x1 represents the amount of money spent on good 1
- p2x2 represents the amount of money spent on good 2
- This means the total amount of money spent on both goods must be less than or equal to the consumer's total income
- The budget set is the set of all affordable consumption bundles at prices (p1, p2) and income m
The Budget Line
- The budget line is the set of all consumption bundles that cost exactly m
- The formula for the budget line is p1x1 + p2x2 = m
- Rearranging it gives: x2 = (m/p2) - (p1/p2)x1
- This formula shows the relationship between the amount of good 1 and good 2 that the consumer can purchase
- The slope of the budget line is - (p1/p2)
- The vertical intercept is (m/p2)
- The horizontal intercept is (m/p1)
Economic Interpretation of the Slope
- The slope of the budget line represents the opportunity cost of consuming good 1
- The opportunity cost is the rate at which the market is willing to substitute good 1 for good 2
- The opportunity cost means if the consumer wants to consume one more unit of good 1, how much of good 2 must they give up to stay within their budget?
Changes in the Budget Constraint
- Changes in Income*
- A change in income, from m to m0 will result in a parallel shift of the budget line
- If m0 is greater than m then the shift will be outward, meaning the consumer can afford more of both goods
- If m0 is less than m then the shift will be inward, meaning the consumer can afford less of both goods
- Changes in Price of Good 1*
- Increasing p1 to p10 will result in a change in the slope of the budget line
- The slope of the budget line will become steeper
- The vertical intercept will stay the same, but the horizontal intercept will change
- This is because the consumer can afford less of good 1 at the higher price
- Changes in the Price of Both Goods*
- Multiplying p1 and p2 by t is the same as dividing income by t
- If t is greater than 1 then the budget line will shift inward, meaning the consumer can afford less
- If t is less than 1 then the budget line will shift outward, meaning the consumer can afford more
- Changes in Both Price and Income*
- If both prices increase and income decreases, then the budget line will shift inward as the consumer can afford less overall
- If price 2 increases more than price 1, then the budget line will become flatter
- If price 2 increases less than price 1, then the budget line will become steeper
The Numeraire
- The budget line is defined by two prices and one income, but one of these variables is redundant
- You can set one of the prices to a fixed value and measure the other price and income relative to that
- Choosing p2 = 1 makes good 2 the Numeraire
- This means the price of good 1 (p1) is now relative to the price of good 2 (which is 1 dollar)
- The income (m) is now also relative to the price of good 2
Taxes, Subsidies and Rationing
- Taxes*
- Quantity tax: A fixed amount is paid for each unit of good 1 consumed
- This increase the price of good 1 by the amount of the tax
- Value tax (ad valorem tax): A tax on the value of good 1
- This is usually in percentage terms
- This increases the price of good 1 by a percentage of the original price
- Subsidies*
- Quantity subsidy: A fixed amount is given to the consumer for each unit of good 1 consumed
- This decreases the price of good 1 by the amount of the subsidy
- Ad valorem subsidy: A subsidy based on the price of the good
- This is also usually in percentage terms
- This decreases the price of good 1 by a percentage of the original price
Rationing
- Rationing is when the amount of a good that can be consumed is limited
- This is represented by a kink in the budget line
Summary
- The budget constraint is a key concept in consumer theory and allows for a graphical representation of what consumers can afford given their income and prices
- The slope of the budget line represents the opportunity cost of consuming good 1
- Changes in income, prices or rationing all impact the budget constraint and the consumer's ability to choose different bundles of goods
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Description
This quiz focuses on the concepts of consumer theory, particularly the budget constraint and how it affects consumer choices. It covers the definitions and equations relevant to understanding how consumers decide on the optimal bundle of goods they can afford. Test your knowledge on the budget line and consumption choices in relation to income and prices.
