Budget equation - Consumer Choice

Budget equation

Lessons

Notes:

Recall the budget line from last section. We will look further into what the equation of this line, and changes that could affect the budget equations.


The Budget Equation

If all income has been used for the goods, then the budget line is expressed by the linear equation:


xPx+yPy=IxP_x+yP_y=I

Where
x → quantity of good x
y → quantity of good y
PxP_x → price of good x
PyP_y → price of good y
I → income

Budget equation

Note: The slope and y-intercept of the budget equation can be found by putting the equation into the form y = mx + b.


xPx+yPy=IxP_x+yP_y=I yPy=xPx+1 yP_y = -xP_x+1

y=PxPyx+IPy y=- \frac{P_x}{P_y}x+\frac{I}{P_y}

Thus,
Slope=PxPy,yintercept=IPy Slope= - \frac{P_x}{P_y},y-intercept=\frac{I}{P_y}

Changes to the Budget Equation


The budget equation can be changed in 6 basic ways.
Increase the price of good x: The consumer will buy less of good x, causing the budget line to be steeper.

Budget equation

Decrease the price of good x: The consumer will buy more of good x, causing the budget line to be less steep.

Decrease the price of good

Increase the price of good y: The consumer will buy less of good y, causing the budget line to be less steep.

Increase the price of good  y

Decrease the price of good y: The consumer will buy more of good y, causing the budget line to be steeper.

Decrease the price of good  y

Increase the Income: The consumer will buy more of both goods, causing the budget line to shift rightward. The slope stays the same.

Increase the Income

Decrease the Income: The consumer will buy less of both goods, causing the budget line to shift leftward. The slope stays the same.

Decrease the Income
  • Intro Lesson
    Budget Equation Overview:
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Budget equation

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