Budget constraint
some
physical limits
Impose
on the consumer problem
Related to finite or scarce
resources
In the static problem it boils
down to
income
expenditure
If we abstract to the
consumption of two goods
x and
y
t
expenditure pock pogy
where
poo is the price per unit of
good 0C
1 per unit of x
x is the quantity of good
Income Exogenous parameter
I lgiven not chosen in themodel
s l
Assumption I non negative
0g are
panumbers
real
The constraint is then
budget
x E 7
poc Pyay
which can be re
expressed as
s
9 Fy Foo
gas
I
99
slope
8J
E
n
so at IC
Poc
in price py pivot the
Changes
budget line
If pg increases to pg
gE
Changes in income
i
I shift the budget
slope remains
unchanged
Comparison between MRS and price ratio
Marginal Rate of substitution
How many units of need
to traded
be y for one
unit of X
keeping utility
constant
when Oc increases
Mitu EEE change
increases
in a
[Link]
Yntts T
Ratio of prices g
85 [Link]
B Hands fig
Unitsofy_
units of a
2 How units of
do many
I need to
Y for one more give
of a
up income constant
keeping
maximization
interpret utility
Howgtographically
MRS
B Budget
constraint
indifference
k
og'd TE
É
Ea I
Suppose 45 U 43 42 u
and note that the MRS is
strictly decreasing
A isfeasible but the consumer
can
improve by moving to any
other with
point strictly
higher utility
B is on the budget line so
all
At
income
this
is
MRS
spent
being
which means
point 904g
that it is possible
to increase the consumption
of Oc and move to a higher
utility levelas with the same
expe diture
in E or reduce
expenditure while keeping utility
constant as in Gl
C is on the budget line so
all income
At this
is being
MRS
spent
which
point
means that it
894g
ispossible
to decrease the consumption
to a
of Oc and move higher
level with the same
utility expe
as in diture
F or reduce
expenditure while keeping utility
constant as in GA
The above logic applies to E
and F by moving to H
which has the highest feasible
and happens at MRS 94g
utility
D is not feasible too expensive
The maximization problem
utility
MAA
Iftratariables
Mpc y
Ft
s t t I I
pock pyy
FInstraint
Observation 1
If utility is strictly increasing
on both goods i.e Max O and May o
It is optimal to spend all
income
pox t
pgy
To solve constrained problems
with
we
multiple variables
the
use
Lagrangian
spay 1 eulogy NII pox g
constraint
Tective
function equalled to
u zero
Lagrange
multiplier
positive
constant
If MRS is
strictly decreasing
then the Foc of the
Lagrangian are
necessary and
sufficient for a maximum
FOC
24 34 Apx o lil
24 34 toy Cii
27 1 pose egg 01in
From i
Hc tox
From ii
a L 99
i on ii
Dividing
E
which means that the optimality
conditioning
I
This together with the budget
constraint allows to find the
Marshall ian demand
Ex Uk y ocky
The utility maximization problem is
MAX
say ochy
sot EI
pact pyy
270 70
y
Before the Lagrangian or optimality
condition We check
a
Utility is strictly increasing
3t EYE o
24 33 70
The budget constraint is binding and
I
Patsy
y
Ii MRS is strictly decreasing
MRS Be z
ymrs
[Link]
372 0
So the Foc of the Lagrangian is necessary
and sufficient for a maximum
The Lagrangian is then
Lossky
FOC
th I
pogy
12 y't Ipx i
332 0
12
212 9 ii
24 toy 0
375 I
per egg 0 Iii
g
From i ii
EE
E
Ey
Then we solve for y in terms
of Sc or vice versa decide
you
y qg
iv
Replace this in the budget constraint
leg iii
I
pox pyy
I pox 9919g
I X t
pox 2Pac x
poe
It
II
Then replacing
sat into in
y g EEE Eg
Y Ey
The solutions of this problem
are the Marshall ian demands
that show the negative relationship
between own and
price quantity
97 T
É
y
Ex 2 U 3 In
sing
x
ay
1 in x
Increasing y
M Ux Be 70 Muy 370
ii Check MRS is
strictly decreasing
3
MRS 4 3 2g
9 7 9
e
21
246,72
32 0
Then the optimality condition
is nec and suf condition a max for
MRS
Eg
solving for oc
x
244
Plugging in the budget constraint
I
ocpxtypy [Link] gp
q
3ypy
y
Ey
Then into 2
244 from above
2
4 4 65 3
Demand Relationship between
price and quantity
i
own
Px a
I
Cross price Relationship between
price of and quantity
y
of x
It
Engel curve
relationship
between income and quantity
In
It
Perfect complements
MRS is not strictly
decreasing
Not always well defined
Discontinuous
Ex he Cosy min
Zay
ya
MAX
min 2
say 19
s t I
pocktogy
Notice that the
happens at the
optimum
corner
of the indifference curve
ex 20C
y
Then into
the
we can
plug
budget constraint
I
pocktogy
pox 2
pyx
Sc
poet 2g I
He
[Link] 2py
From 2x
y
at Efg
cross price demand
complements As
I
4 get more
Gif
g
x given
that I
i
get them
fitedprop
Perfect substitutes
a
logy 2aty
Indifference curves
Fix it solve for
y
E 2x
g
tie
MRS
My 7 2
toy
set I p
catgy
Eti
increasing
I
MRS
Ey
I was
willing to give up
more units of for
1 unit of x with
y
my
preferencences than the
trade implied
To
by prices
increase
to utility I had
increase the consumption
of Oc
If MR S
MMI Ey
ME
d
Matt
[Link]
y
o a
Ex
if MRS
Fy
act 10 EI if MRS
if MRS
00 sq
if MRS
Ey
y't Io Eg if Mrs
9g
E if Mrs
egg
Graph for MR 5
95
It
Ex M e
3
ay 29
pox 41 i pay 1 1 10
What is the optimal consumption
IS MRS 32 Et 4 89
ye 4
X O 10
By that
E
it
y 19 10 2 0
Ey
strictly increasing MRS
ex
relay sooty
MRS
y
diff__Gtx
1 551
o
ytyÉ
LII Pg
If MRS then
strictly
check both corner solutions
and choose the one
with the highest utility
i 2 0
D Egg
ii
y o X
É
Y p
M O
E Eg
M
Elo IE
i is preferred if
F If pay
ii is preferred if
pg px
if peg I will
choose either i or ii
NOT A COMBINATION
OF BOTH
Quasi linear preferences
Ex In
Mkay scary
MRS E
E
9 LO
Max L O May so
We can use the
optimality condition
E É
go
To
find my we
plug
at on the
constraint
budget
I pox egg
a He toy
g Fy E r
We have than 270 and
o
g
Note that y o if
I
spy so
y 0
Then
y 55 if I
as
I
if pry
Me if I a
Eg if I spy
Exercise c heck that if
Mkay acting
so
FI if I ex
0 if Ipx
y E if I ex
if Iepx
i
Market for attention
MAY I In St Eln G
S.t M W 12
5 12Ml Geron
S Effective time watching
content
G Grade in the class
N Time spent on Netflix
app hours
W Hours worked in class
Take S EN solve
for N i N 25
Take G lows solve
for W W
into the time
Replace
constraint Nt W 12
Sot 25 8 12
2
Ps 96 t
s G
Isn W
Timatyconation
ME 8 85 8
Solve for G
6 5 5