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Questions and Answers
What does the slope of the budget line represent?
What does the slope of the budget line represent?
- The fixed cost of consuming good 1
- The total income of the consumer
- The maximum quantity of good 2 that can be purchased
- The rate at which good 1 can be substituted for good 2 (correct)
How can the intercept on the vertical axis be calculated?
How can the intercept on the vertical axis be calculated?
- p1/m
- p2/m
- m/p1
- m/p2 (correct)
If the consumer increases consumption of good 1 by $Δx1$, how does consumption of good 2 change?
If the consumer increases consumption of good 1 by $Δx1$, how does consumption of good 2 change?
- It increases by Δx2
- It decreases by Δx2 (correct)
- It remains unchanged
- It increases regardless of Δx1
Which equation represents the budget constraint?
Which equation represents the budget constraint?
What economic concept does the negative slope of the budget line illustrate?
What economic concept does the negative slope of the budget line illustrate?
If a consumer has an income of m and spends it entirely on good 1, what is the maximum amount of good 1 she can buy?
If a consumer has an income of m and spends it entirely on good 1, what is the maximum amount of good 1 she can buy?
When deriving the slope of the budget line using the change in consumption of goods, which relationship is observed?
When deriving the slope of the budget line using the change in consumption of goods, which relationship is observed?
What does the horizontal intercept indicate on the budget line?
What does the horizontal intercept indicate on the budget line?
What effect does a subsidy have on the price of good 1 from the consumer's viewpoint?
What effect does a subsidy have on the price of good 1 from the consumer's viewpoint?
What effect does increasing the price of good 1 have on the budget line?
What effect does increasing the price of good 1 have on the budget line?
How does an ad valorem subsidy affect the price of good 1?
How does an ad valorem subsidy affect the price of good 1?
Which statement best describes a lump-sum tax?
Which statement best describes a lump-sum tax?
What happens to the budget line when both good prices are doubled?
What happens to the budget line when both good prices are doubled?
How can price changes be algebraically expressed?
How can price changes be algebraically expressed?
What is the consequence of a lump-sum subsidy on the budget line?
What is the consequence of a lump-sum subsidy on the budget line?
What happens to the budget set when a good is subjected to rationing constraints?
What happens to the budget set when a good is subjected to rationing constraints?
If prices increase and income decreases simultaneously, what happens to the budget line?
If prices increase and income decreases simultaneously, what happens to the budget line?
What happens to the slope of the budget line if price 2 increases more than price 1?
What happens to the slope of the budget line if price 2 increases more than price 1?
How does a quantity tax affect the budget line?
How does a quantity tax affect the budget line?
What is the purpose of pegging one price or income to a fixed value?
What is the purpose of pegging one price or income to a fixed value?
What happens to the price consumers face when a tax is applied?
What happens to the price consumers face when a tax is applied?
Which scenario best illustrates an ad valorem subsidy?
Which scenario best illustrates an ad valorem subsidy?
What does the equation $p_1 x_1 + p_2 x_2 = m$ represent?
What does the equation $p_1 x_1 + p_2 x_2 = m$ represent?
What is the significance of dividing the budget line equation by $p_2$?
What is the significance of dividing the budget line equation by $p_2$?
What happens if a consumer chooses to consume less than their desired amount of a good?
What happens if a consumer chooses to consume less than their desired amount of a good?
In which scenario is it important to recognize the discrete nature of goods?
In which scenario is it important to recognize the discrete nature of goods?
How are bundles of goods that are considered at least as good as a particular bundle represented?
How are bundles of goods that are considered at least as good as a particular bundle represented?
Why might people avoid choosing excessive amounts of goods?
Why might people avoid choosing excessive amounts of goods?
When might it be more convenient to think of a good as a continuous variable rather than a discrete one?
When might it be more convenient to think of a good as a continuous variable rather than a discrete one?
What do well-behaved preferences in economics typically illustrate?
What do well-behaved preferences in economics typically illustrate?
Why are indifference curves important in understanding consumer choice?
Why are indifference curves important in understanding consumer choice?
How can preferences for discrete goods impact a consumer's purchasing decisions?
How can preferences for discrete goods impact a consumer's purchasing decisions?
What must be true for there to be no movement from the point (x1, x2)?
What must be true for there to be no movement from the point (x1, x2)?
What does the slope of the indifference curve represent?
What does the slope of the indifference curve represent?
Which scenario occurs when the exchange rate differs from the marginal rate of substitution (MRS)?
Which scenario occurs when the exchange rate differs from the marginal rate of substitution (MRS)?
Why can the marginal rate of substitution be referred to as the marginal willingness to pay?
Why can the marginal rate of substitution be referred to as the marginal willingness to pay?
What does a consumer want to do if the rate of exchange equals the marginal rate of substitution?
What does a consumer want to do if the rate of exchange equals the marginal rate of substitution?
What happens if the exchange line cuts the indifference curve?
What happens if the exchange line cuts the indifference curve?
How is the rate at which the consumer is willing to substitute one good for another described?
How is the rate at which the consumer is willing to substitute one good for another described?
When considering consumption, what are consumers able to measure through the MRS?
When considering consumption, what are consumers able to measure through the MRS?
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Study Notes
Budget Line and Intercepts
- The budget line formula is defined as ( p_1x_1 + p_2x_2 = m ) with vertical intercept ( m/p_2 ) and slope ( -p_1/p_2 ).
- Horizontal intercept indicates the total quantity of good 1 purchasable with full income, ( m/p_1 ), while vertical intercept shows the maximum quantity of good 2, ( m/p_2 ).
Slope and Substitution Rate
- The slope of the budget line represents the market's willingness to substitute good 1 for good 2.
- Change in consumption must satisfy budget constraints: ( p_1 \Delta x_1 + p_2 \Delta x_2 = 0 ).
- The rate of substitution is determined as ( \Delta x_2 / \Delta x_1 = -p_1 / p_2 ).
- This slope is interpreted as the opportunity cost of consuming good 1 in terms of good 2.
Impact of Price Changes
- Doubling the prices of both goods shifts the budget line inward by half, altering both intercepts.
- When both prices rise while income decreases, the budget line also shifts inward.
Numeraire and Budget Set
- Budget lines can be normalized by pegging either price or income, rendering one variable redundant.
- An ad valorem subsidy reduces the effective price of good 1, making the budget line flatter.
- Taxes increase the price for consumers; subsidies decrease it.
Rationing Constraints
- Rationing limits consumption of certain goods; budget sets depicted without affordable combinations exceeding set limits.
- Most goods have diminishing returns, and consumer preferences generally favor consuming less than the maximum available.
Discrete Goods
- Goods may be consumed in whole numbers (e.g., automobiles); preferences for discrete goods can be modeled with distinct points along a continuum.
- Indifference curves for discrete goods appear as segmented rather than continuous patterns.
Preferences and Marginal Rate of Substitution (MRS)
- Indifference curves illustrate the trade-off willingness between goods; the slope corresponds to MRS.
- Consumers prefer a balance between two goods, defined at points where the exchange line is tangent to the indifference curve.
- MRS can also reflect marginal willingness to pay for additional units of goods relative to substitutes.
Summary
- The budget constraint is fundamental to consumer choice, illustrating trade-offs between two goods based on prices and income.
- Variations in price and income directly affect purchasing behavior and budget line positioning.
- Understanding consumer preferences through indifference curves and MRS provides insight into optimal consumption decisions.
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