C. What do we want to do with the theory 3. use observed behavior to estimate underlying value &5 is adequate to describe consumer behavior 2. predict how behavior changes as economic environ a)cost-benefit analysis b)predicting impact of some policy D. Consumption bundle 1.(a1, T2)-how much of each good is consumed es of the two goods 3. m- money the consumer has to spend 4. budget constraint: P101+P2T2 < m 5. all(r1, I2) that satisfy this constraint make up the budget set of the consumer. See Figure 2.1 1. theory works with more than two goods, but cant draw pictures 2. often think of good 2(say)as a composite good, representing money to spend on other goods 3. budget constraint becomes P1T1+a2< 4. money spent on good 1 (p1I1) plus the money spent on good 2(a2)has to be less than or equal to the amount available(m) 1.p11+p2x2=m 2. also written as T2=m/p2-(p1/p2)T 3. budget line has slope of -pi/p2 and vertical intercept of m/p 4. set a1=0 to find vertical intercept(m/p2);set r2=0 to find horizontal intercept(m/pi) 5. slope of budget line measures opportunity cost of good 1- how much of good 2 you must give up in order to consume more of go G. Changes in budget line 1. increasing m makes parallel shift out. See Figure 2 2. increasing Pi makes budget line steeper. See Figure 2.3 3. increasing p2 makes budget line fatter 4. just see how intercepts change 5. multiplying all prices by t is just like dividing Income 6. multiplying all prices and income by t doesnt change budget line a)"a perfectly balanced infation doesn't change consumption possibili- H. The numeraire 1. can arbitrarily assign one price a value of l and measure other price relative to that 2. useful when measuring relative prices; e. g, English pounds per dollar, 1987 dollars versus 1974 dollars. etc. axes, subsidies, and rationing 1. quantity tax - tax levied on units bought: pi +t 2. value tax -tax levied on dollars spent: P1 TPI. Also known as ad 3. subsidies -opposite of a tax a)Chapter 2 5 C. What do we want to do with the theory? 1. test it — see if it is adequate to describe consumer behavior 2. predict how behavior changes as economic environment changes 3. use observed behavior to estimate underlying values a) cost-benefit analysis b) predicting impact of some policy D. Consumption bundle 1. (x1, x2) — how much of each good is consumed 2. (p1, p2) — prices of the two goods 3. m — money the consumer has to spend 4. budget constraint: p1x1 + p2x2 ≤ m 5. all (x1, x2) that satisfy this constraint make up the budget set of the consumer. See Figure 2.1. E. Two goods 1. theory works with more than two goods, but can’t draw pictures. 2. often think of good 2 (say) as a composite good, representing money to spend on other goods. 3. budget constraint becomes p1x1 + x2 ≤ m. 4. money spent on good 1 (p1x1) plus the money spent on good 2 (x2) has to be less than or equal to the amount available (m). F. Budget line 1. p1x1 + p2x2 = m 2. also written as x2 = m/p2 − (p1/p2)x1. 3. budget line has slope of −p1/p2 and vertical intercept of m/p2. 4. set x1 = 0 to find vertical intercept (m/p2); set x2 = 0 to find horizontal intercept (m/p1). 5. slope of budget line measures opportunity cost of good 1 — how much of good 2 you must give up in order to consume more of good 1. G. Changes in budget line 1. increasing m makes parallel shift out. See Figure 2.2. 2. increasing p1 makes budget line steeper. See Figure 2.3. 3. increasing p2 makes budget line flatter 4. just see how intercepts change 5. multiplying all prices by t is just like dividing income by t 6. multiplying all prices and income by t doesn’t change budget line a) “a perfectly balanced inflation doesn’t change consumption possibili￾ties” H. The numeraire 1. can arbitrarily assign one price a value of 1 and measure other price relative to that 2. useful when measuring relative prices; e.g., English pounds per dollar, 1987 dollars versus 1974 dollars, etc. I. Taxes, subsidies, and rationing 1. quantity tax — tax levied on units bought: p1 + t 2. value tax — tax levied on dollars spent: p1 + τp1. Also known as ad valorem tax 3. subsidies — opposite of a tax a) p1 − s b) (1 − σ)p1