University of Hawaii at Manoa Department of Economics

1
University of Hawaii at ManoaDepartment 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 consumers income (consumers 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 consumers budget.
• Pxx Pyy B.

6
The Consumers Budget Set

• The Consumers 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 consumers budget.
• Budget Set (x,y) Pxx Pyy B .

7
The Consumers 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
A
N
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