Economics Budget Line and Intercepts Quiz

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Questions and Answers

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?

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?

It increases by Δx2

It decreases by Δx2 (correct)

It remains unchanged

It increases regardless of Δx1

Which equation represents the budget constraint?

p1x1 + p2x2 = m Signup and view all the answers

What economic concept does the negative slope of the budget line illustrate?

Opportunity cost Signup and view all the answers

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?

m/p1 Signup and view all the answers

When deriving the slope of the budget line using the change in consumption of goods, which relationship is observed?

Δx2 = -p1/p2 * Δx1 Signup and view all the answers

What does the horizontal intercept indicate on the budget line?

The maximum quantity of good 1 that can be purchased Signup and view all the answers

What effect does a subsidy have on the price of good 1 from the consumer's viewpoint?

It decreases the price to the consumer. Signup and view all the answers

What effect does increasing the price of good 1 have on the budget line?

It becomes steeper. Signup and view all the answers

How does an ad valorem subsidy affect the price of good 1?

Price is adjusted by a percentage of the original price. Signup and view all the answers

Which statement best describes a lump-sum tax?

It takes away a fixed amount of money regardless of behavior. Signup and view all the answers

What happens to the budget line when both good prices are doubled?

It shifts inward by half. Signup and view all the answers

How can price changes be algebraically expressed?

As a multiplication of both prices and income by a constant. Signup and view all the answers

What is the consequence of a lump-sum subsidy on the budget line?

It shifts the budget line outward. Signup and view all the answers

What happens to the budget set when a good is subjected to rationing constraints?

A portion of the budget set is removed. Signup and view all the answers

If prices increase and income decreases simultaneously, what happens to the budget line?

It shifts inward. Signup and view all the answers

What happens to the slope of the budget line if price 2 increases more than price 1?

The slope becomes flatter. Signup and view all the answers

How does a quantity tax affect the budget line?

It shifts the budget line inward or outward depending on the taxed good. Signup and view all the answers

What is the purpose of pegging one price or income to a fixed value?

To reduce the number of variables. Signup and view all the answers

What happens to the price consumers face when a tax is applied?

The price increases. Signup and view all the answers

Which scenario best illustrates an ad valorem subsidy?

Receiving $5 for every $10 spent on groceries. Signup and view all the answers

What does the equation $p_1 x_1 + p_2 x_2 = m$ represent?

The consumer's budget constraint. Signup and view all the answers

What is the significance of dividing the budget line equation by $p_2$?

It simplifies the budget line into a usable form. Signup and view all the answers

What happens if a consumer chooses to consume less than their desired amount of a good?

They will likely feel worse off. Signup and view all the answers

In which scenario is it important to recognize the discrete nature of goods?

When consumers are choosing only one or two units of a good. Signup and view all the answers

How are bundles of goods that are considered at least as good as a particular bundle represented?

As a set of discrete points. Signup and view all the answers

Why might people avoid choosing excessive amounts of goods?

Because excess leads to dissatisfaction. Signup and view all the answers

When might it be more convenient to think of a good as a continuous variable rather than a discrete one?

When consumers are purchasing large quantities. Signup and view all the answers

What do well-behaved preferences in economics typically illustrate?

The convenience of using simple diagrams. Signup and view all the answers

Why are indifference curves important in understanding consumer choice?

They illustrate consumer satisfaction across varying goods. Signup and view all the answers

How can preferences for discrete goods impact a consumer's purchasing decisions?

They limit consumers to integer amounts only. Signup and view all the answers

What must be true for there to be no movement from the point (x1, x2)?

The exchange line is tangent to the indifference curve. Signup and view all the answers

What does the slope of the indifference curve represent?

The marginal rate of substitution. Signup and view all the answers

Which scenario occurs when the exchange rate differs from the marginal rate of substitution (MRS)?

The consumer would want to trade one good for the other. Signup and view all the answers

Why can the marginal rate of substitution be referred to as the marginal willingness to pay?

It shows how many dollars would be sacrificed for more of good 1. Signup and view all the answers

What does a consumer want to do if the rate of exchange equals the marginal rate of substitution?

Stay at the current consumption point. Signup and view all the answers

What happens if the exchange line cuts the indifference curve?

The consumer can reach a more preferred point. Signup and view all the answers

How is the rate at which the consumer is willing to substitute one good for another described?

Marginal rate of substitution. Signup and view all the answers

When considering consumption, what are consumers able to measure through the MRS?

The adjustment needed to keep utility constant. Signup and view all the answers

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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Description

Test your understanding of the budget line formula, intercepts, and the impact of price changes on consumption. This quiz explores concepts like the slope of the budget line and the substitution rate. Perfect for students learning about consumer choice theory!