Consumption一 budgets Price Changes and Endowments An increase in either of the endowments is just like an increase in income. In the graph below the endowment of good I increases from w1 to w- The endowment of good 2 and both prices remain constant. Old slop An increase in the price of good 1 is slightly mplicated. Suppose the price increases from Pi to Pi. Recall the slope of the budget line is given by -pi/pz. This will increase (in absolute value)and hence the budget line becomes steeper. However, it does not pivot around the intercept with the vertical axis, as before. The endow affordable and so the budget line will still intersect with that point as illustrated in the second Notice that if wn increased and w2 decreased (or vice-versa) it is possible for the budget line to shift outward. Consumption- Budgets Optimal Choice An economic model of consumption-"Consumers choose the most preferred bundle from their budget sets. This can be illustrated graphically by the following important picture Higher indifference curves correspond to higher utility levels. Therefore, the consumer chooses the bundle from the budget set which lies on the highest indifference curve. This is called the optimal choice -r'=(ri, ri).Consumption — Budgets 7 Price Changes and Endowments • An increase in either of the endowments is just like an increase in income. In the graph below the endowment of good 1 increases from ω1 to ω 0 1 . The endowment of good 2 and both prices remain constant. . . . ................................................................................................................................................................................................................................................................................ ............. ............. ............. ............. ............. ............. ............. . . . . . . . . . . . ............. ............. ..... x2 0 x1 Slope = −p1/p2 Old slope = −p1/p2 New slope = −p 0 1/p2 ω1 ω2 ω 0 1 ω1 ω2 . ........ ........ ..... .................................... ............... ..................... .................................................................................................................................................................................................................................................................................. . . x2 0 x1 • An increase in the price of good 1 is slightly more complicated. Suppose the price increases from p1 to p 0 1 . Recall the slope of the budget line is given by −p1/p2. This will increase (in absolute value) and hence the budget line becomes steeper. • However, it does not pivot around the intercept with the vertical axis, as before. The endowment must still be just affordable and so the budget line will still intersect with that point, as illustrated in the second graph above. • Notice that if ω1 increased and ω2 decreased (or vice-versa) it is possible for the budget line to shift outward, inward or even remain where it started. Consumption — Budgets 8 Optimal Choice • An economic model of consumption — “Consumers choose the most preferred bundle from their budget sets.” • This can be illustrated graphically by the following important picture. ............. ............. ............. ............. ......... . . . . . ................................................................................................................................................................................................................................................................................ . 0 x2 x1 x ∗ 2 x ∗ 1 . ........ ......... .... . ................................................................................................ . .......................................................................... . ........................................................................... • Higher indifference curves correspond to higher utility levels. Therefore, the consumer chooses the bundle from the budget set which lies on the highest indifference curve. This is called the optimal choice — x ∗ = (x ∗ 1 , x ∗ 2 )