A Few Applications of Review Material

1. A Few Applications of Review Material Budget Constraints Isocosts Utility Functions Production Functions

2. Deriving the Budget Constraint A consumer consumes goods X and Y, which have prices Px and Py with income I Expenditures are: PxX + PyY Along the budget constraint, all income is spent: PxX + PyY = I

3. Budget Constraint algebra Intercept: Slope:

4. Budget Constraint Y • The affordable bundles are together known at the Opportunity Set or Budget Set Not affordable I/Py Slope = -Px/PY Affordable X I/Px

5. Budget Constraint for Three Commodities x2 p1x1 + p2x2 + p3x3 = I This is a plane instead of a line. I /p2 I/p3 x3 I /p1 x1

6. Change in income: pay raise Y X

7. Change in price: X gets cheap Y X

8. Example: The Food Stamp Program • Consider the two good example where consumers purchase food (F) and all other goods are lumped into one category (G). • Suppose I = $100, pF = $1 and the price of “other goods” is pG = $1. • The budget constraint is then F + G =100.

9. Example: The Food Stamp Program G F + G = 100: before stamps. 100 F 100

10. Example: The Food Stamp Program • Now assume that the government offers each family food stamps worth $40. • Draw the new budget constraint of a typical family.

11. Example: The Food Stamp Program G 100 Budget set after 40 foodstamps issued. The family’s budgetset is enlarged. F 40 100 140