EC109: Microeconomics I
2021 - 2022
Live Lecture Week 2
Professor Elizabeth Jones
Join at [Link] ID: 161-768-871
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The plan for today…
A reminder about the slope of the budget constraint
Exogenous versus endogenous income
Another budget constraint exercise
Pre-class question Week 1 Q5e
Relaxing some of the assumptions of preferences
An indifference curve exercise (if we have time)
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Slope of budget constraint
When we have our budget constraint, we rearrange it to give an
expression in terms of the good on the vertical axis, so we can easily
see the vertical intercept and slope:
= + becomes = −
It really depends on which good we are talking about when we
change its quantity (think about opportunity cost)
The slope is written as the price of the good on the horizontal axis
divided by the price of the good on the vertical axis
Exogenous v endogenous income
Exogenous income (determined outside the model)
– For example, a consumer has an income M or an income of £200
Endogenous income (determined inside the model)
– Your income is now determined by your endowments
– For example, you have 5 macro textbooks and 6 micro textbooks
– The price of a macro textbook is £50 and a micro textbook is £60
– What is your income?
It is now determined by the number of goods you have and
how much you can sell them for.
– So income is now determined within the model and not just given as M
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Budget Constraint Question
Consider two goods X and Y (X on horizontal axis). Assume income
is M and the prices of X and Y are denoted and respectively.
Draw the budget constraint for these two goods. Assume that X is
Pasta and Y is coffee. What will happen to the budget constraint if:
a) The government imposes a quantity tax (t) on coffee?
b) The government imposes a lump sum tax?
c) The government rations pasta to ̅ ?
d) The government imposes a tax, t, on pasta consumed beyond ̅ ?
Budget Constraint Question
Consider two goods X and Y (X on horizontal axis). Assume income
is M and the prices of X and Y are denoted and respectively.
Draw the budget constraint for these two goods. Assume that X is
Pasta and Y is coffee. What will happen to the budget constraint if:
a) The government imposes a quantity tax (t) on coffee?
b) The government imposes a lump sum tax?
c) The government rations pasta to ̅ ?
d) The government imposes a tax, t, on pasta consumed beyond ̅ ?
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(c) The government rations pasta to ̅ ?
(d) The government imposes a tax, t, on pasta consumed beyond ̅ ?
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Pre-Class Question Week 1 5e
Carlotta receives an in-kind transfer of Jam ( )
Bananas
Jam
Relaxing some of the assumptions
a) Draw an indifference curve where x1 is essential, but x2 is non-essential.
b) Construct an indifference map for a consumer who consumes goods x1
and x2 and where there is a satiation point such that there is an overall
best bundle.
c) Draw an indifference curve for a consumer making a choice between
Chocolate and Broccoli, where broccoli is assumed to be a ‘bad’ good.
d) Say you are stranded on a deserted island, with no hope of rescue.
There are two ‘goods’, which are ‘Amount of cash’ and ‘units of food per
week’. Construct an indifference map for this scenario, where we are
thinking about ‘cash’ as a useless good – after all, it’s useless on a
deserted island!
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Indifference Curves
Consider Greg’s tastes for consumption and leisure and assume that his
tastes satisfy the 5 basic assumptions.
a) On a graph with leisure hours per week on the horizontal axis and consumption per
week (in pounds) on the vertical axis, illustrate an example of three indifference
curves that satisfies our assumptions.
b) Now redefine the good on the horizontal axis as ‘labour hours’ rather than ‘leisure
hours’. What would the indifference curves now look like?
c) How would both of your graphs change if tastes over leisure and consumption were
non-convex, i.e. if averages were worse than extremes?
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Indifference Curves
Consider Greg’s tastes for consumption and leisure and assume that his
tastes satisfy the 5 basic assumptions.
d) If your tastes over consumption and leisure could be described by the utility function
, = / / . Do these tastes satisfy our 5 basic assumptions?
e) Can you find a utility function that would describe the same tastes when the first
good is defined as labour hours instead of leisure hours? (Hint: Suppose your weekly
endowment of leisure time is 60 hours. How do labour hours relate to leisure hours?)
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