budgetconstraints.pptVIP

? 2009 Pearson Addison-Wesley. All rights reserved. ? 2009 Pearson Addison-Wesley. All rights reserved. Budget Constraints ECO61 Udayan Roy Fall 2008 Prices, quantities, and expenditures PX is the price of good X It is measured in dollars per unit of good X The consumer pays this price no matter what quantity she buys. That is, there are no quantity discounts and there is no rationing X is also the quantity of good X that is purchased by the consumer It is measured in units of good X per unit of time PX ? X = PXX is the consumer’s expenditure on good X Budget constraint Assume a world with only two consumer goods, X and Y Total expenditure = PXX + PYY M is the consumer’s income or budget The consumer cannot spend more than her budget allows PXX + PYY ≤ M is the consumer’s budget constraint “More-is-better” implies budget exhaustion A rational consumer will spend every penny available. PXX + PYY ≤ M becomes PXX + PYY = M Here’s an example: Saving The budget constraint PXX + PYY = M does not imply that saving is being ignored. We saw earlier that, to an economist, “food delivered now” and “food delivered in the future” are different goods The former could be our good X and the latter could be good Y Then PYY would represent saving for the future. Saving You may pay today for something that will be delivered at some date in the future. For example, you may pay Long Island University today for courses you plan to take in 2015 You may pay today to reserve hotel rooms in London for the 2012 Olympics You may pay today for the future delivery of the National Geographic magazine These purchases are the same as saving for the future. Budget constraint algebra Budget constraint algebra If X = 0, then Y = M/PY This is the maximum amount of good Y that the consumer can buy Similarly, the maximum amount of good X that the consumer can buy is M/PX If the consumer’s income (M) increases, both maximums will increase by the same proportion Budget Constraint: Graph PSS + PBB =