Tuesday, 15 June y
Micro year 2 notes
1.1 Consumer theory
Sum up
- Micro- simple models to understand the real world- gained through as-
sumptions
- Consumer chooses the best bundle of goods they can afford
- Budget constraint identifies what he can afford to buy pxX + pyY=M
- Slope of budget line- rate of substitution of one good for the other- opp
cost
- Change in y/change in x= - Px/Py
- If m Px or Py change- new budget constraint- changing m changes inter-
cept not slope though- either Px or Py changes slope
- Government intervention: Taxes subsidises affect prices tax- rationing
change budget line and budget set
- e.g changing in income affect budget constraint
- Preferences show which bundle is the best- indifference curves were
drawn and assumptions about behaviour made
- Utility function used to describe preferences- use ordinal utility
Budget constraint
Importance
- Based on the idea the consumers chooses the best bundle of goods he
can afford
- Identities what they can afford to buy
- Consumer theory wants to know how changes in budget constraint
changes consumption
Standard consumer problem
- Two goods X and Y at prices: Px and Py
- Consumption bundle (x,y) tells us the consumer gets x units of good X
and y good Y
- Bundle (x,y) only feasible if PxX + PyY<M (less or equal to M)
1
, Tuesday, 15 June y
- Gives us set of affordable bundles of good X and Y
- M = income
An equation for the budget constraint
- Budget line/constraint- set of consumption bundles that cost the exactly
income
- If we assume the consumer spends all income:
- y= m/Py - PxX/Py we get a line- budget constraint
- Budget set- all bundles that are affordable at given prices/income
- Anything to left of line in budget set- can afford it
Interpretation of the line
- Slope of the line- rate of substitution for one good for the other- oppor-
tunity cost
- How much of good y is the con-
sumer willing to give up to get
more good x
- Operate in opposite directions as if you increase good y- good x must go
down
- Hence it being = to negative Px/Py
Factors that affect the budget constraint
- Slope and position affected by income and relative prices
- Changes in income shift budget constraint- change intercept- can buy
more of both
- Change in price pivots budget constraint- on one of them
2
, Tuesday, 15 June y
- Increase in price of Y (Py) pivots curve down slope/y decreases and
vice versa
- If M Px or Py change- line changes- Px/y changes slope- M shifts curve
- If prices change the same e.g both double- slope unaffected
Effects of tax/subsidies
- Value Tax- (ad valorem) tax on price of purchased good- %
- Unit tax- per unit purchased
- In case of a quantity tax- buyers pay higher price than seller receives
Pd= Ps+tax
- Pd is price paid by consumers
- In case of subsidy Pd=Ps-subsidy or Ps=Pd + subsidy
- Value Subsidy- govt gives a & back of good
- Quantity subsidy- per purchased unit
Taxes subsidies and rationing
- Lump sum tax- government takes away a fixed amount regardless of
the consumers behaviour- budget shifts in as income reduced
- Rationing- maximum level of consumption is fixed, x bar is max you can
consume of good x
- Combinations of tax subsidies and rationing- good x consumed at a
price p below a certain quantity x bar and a tax introduced becomes p
+ t for any additional unit
3
, Tuesday, 15 June y
Preferences
intro
- Consumer chooses the best bundle of goods that a consumer can afford.
- No bundles where A>B and B<A- binary relation
- Weakly prefers can also mean indifferent
Consistency assumptions
- Completeness- any two bundles can be compared- consumer can say
which they prefer
- Reflexivity- and bundle is at least as good as itself
- Transitivity- if a>b and b>c then A>c
- Makes assumption that consumer is rational
- If preferences aren’t consistent- cant say anything about a consumer
nor can you build a model
Indifference curves
- Plots a set of bundles between which the consumer is indifferent- de-
scribe consumer preferences
- Indifference curves cannot cross- transivity
4
Micro year 2 notes
1.1 Consumer theory
Sum up
- Micro- simple models to understand the real world- gained through as-
sumptions
- Consumer chooses the best bundle of goods they can afford
- Budget constraint identifies what he can afford to buy pxX + pyY=M
- Slope of budget line- rate of substitution of one good for the other- opp
cost
- Change in y/change in x= - Px/Py
- If m Px or Py change- new budget constraint- changing m changes inter-
cept not slope though- either Px or Py changes slope
- Government intervention: Taxes subsidises affect prices tax- rationing
change budget line and budget set
- e.g changing in income affect budget constraint
- Preferences show which bundle is the best- indifference curves were
drawn and assumptions about behaviour made
- Utility function used to describe preferences- use ordinal utility
Budget constraint
Importance
- Based on the idea the consumers chooses the best bundle of goods he
can afford
- Identities what they can afford to buy
- Consumer theory wants to know how changes in budget constraint
changes consumption
Standard consumer problem
- Two goods X and Y at prices: Px and Py
- Consumption bundle (x,y) tells us the consumer gets x units of good X
and y good Y
- Bundle (x,y) only feasible if PxX + PyY<M (less or equal to M)
1
, Tuesday, 15 June y
- Gives us set of affordable bundles of good X and Y
- M = income
An equation for the budget constraint
- Budget line/constraint- set of consumption bundles that cost the exactly
income
- If we assume the consumer spends all income:
- y= m/Py - PxX/Py we get a line- budget constraint
- Budget set- all bundles that are affordable at given prices/income
- Anything to left of line in budget set- can afford it
Interpretation of the line
- Slope of the line- rate of substitution for one good for the other- oppor-
tunity cost
- How much of good y is the con-
sumer willing to give up to get
more good x
- Operate in opposite directions as if you increase good y- good x must go
down
- Hence it being = to negative Px/Py
Factors that affect the budget constraint
- Slope and position affected by income and relative prices
- Changes in income shift budget constraint- change intercept- can buy
more of both
- Change in price pivots budget constraint- on one of them
2
, Tuesday, 15 June y
- Increase in price of Y (Py) pivots curve down slope/y decreases and
vice versa
- If M Px or Py change- line changes- Px/y changes slope- M shifts curve
- If prices change the same e.g both double- slope unaffected
Effects of tax/subsidies
- Value Tax- (ad valorem) tax on price of purchased good- %
- Unit tax- per unit purchased
- In case of a quantity tax- buyers pay higher price than seller receives
Pd= Ps+tax
- Pd is price paid by consumers
- In case of subsidy Pd=Ps-subsidy or Ps=Pd + subsidy
- Value Subsidy- govt gives a & back of good
- Quantity subsidy- per purchased unit
Taxes subsidies and rationing
- Lump sum tax- government takes away a fixed amount regardless of
the consumers behaviour- budget shifts in as income reduced
- Rationing- maximum level of consumption is fixed, x bar is max you can
consume of good x
- Combinations of tax subsidies and rationing- good x consumed at a
price p below a certain quantity x bar and a tax introduced becomes p
+ t for any additional unit
3
, Tuesday, 15 June y
Preferences
intro
- Consumer chooses the best bundle of goods that a consumer can afford.
- No bundles where A>B and B<A- binary relation
- Weakly prefers can also mean indifferent
Consistency assumptions
- Completeness- any two bundles can be compared- consumer can say
which they prefer
- Reflexivity- and bundle is at least as good as itself
- Transitivity- if a>b and b>c then A>c
- Makes assumption that consumer is rational
- If preferences aren’t consistent- cant say anything about a consumer
nor can you build a model
Indifference curves
- Plots a set of bundles between which the consumer is indifferent- de-
scribe consumer preferences
- Indifference curves cannot cross- transivity
4
