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Principles of Microeconomics Lecture 2 - budget constraint and prefernces
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the economics of preferences and and Budget constraints are discussed in these lecture notes.
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Principles of Microeconomics Lecture 2 –Budget constraint
Consumers choose the best bundle of goods that they can afford (rational)
A consumption choice set is the collection of all consumption choices available to the consumer
A consumption choice set is constrained by certain factors
o Budget
o Time
A bundle of goods is affordable when p1x1+p2x2…pnxn > m
The bundles which are only just affordable form the consumers budget constraint
o p1x1+p2x2…pnxn = m
this formula can be rearranged to x 2 = -(p1/p2)x1 + m/p2
the area under the budget constraint is known as the budget set
when income increases no original bundles are lost, instead we gain new available bundles
there are certain instances in which prices are not constants due to things like govt taxes or offers on the
good (bulk buy)
as a result of prices not being constant the budget constraint may change shape and no longer remain a
straight line
Consumer preferences
behavioural postulate
o a decision maker always chooses its most preferred alternative
strict preference = x is more preferred than y is
weak preference = x is slightly preferred to y
indifferent preference = indifferent to x or y
any bundle x Is always at least as preferred as itself
transitivity occurs when: if I prefer x to y, and y to z, then it follows that I prefer x to z
from this we are able to rank bundles. If X is on indifference curve 1 and Y is on indifference curve 2 (above
1) Y is preferred to X. If Z is on the same curve as Y (curve 2) it follows that Z is also preferred to X
when more of a commodity is always preferred, the commodity is a good
the indifference curve of a goods are negatively sloped
if less of a commodity is always preferred then the commodity is a bad
a bad has a positively sloped indifference curve
if a consumer always regards units of commodities 1 and 2 as equivalent, then the commodities are perfect
substitutes and only the total amount of the two commodities in the bundle determines the preference rank
order
if a consumer always consumes commodities 1 and 2 in fixed proportion, then the commodities are perfect
complements and only the number of pairs of units determines the rank order of the preferences
a bundle strictly preferred to any other point is a stationary point
a preference relation is “well-behaved” if it is –
o monotonic: more of any commodity is always preferred
o convexity: mixtures of bundles are preferred to the bundles themselves
marginal rate of substitution is the slope of the indifference curve
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