Understanding Linear Budget Constraints, Shifts, Tilts, and Tax Impact, Study notes of Economics

Download Understanding Linear Budget Constraints, Shifts, Tilts, and Tax Impact and more Study notes Economics in PDF only on Docsity! Topic 5 Topic 5 “Budget Constraints” - Form for Linear Budget Constraint - Shifts in the budget constraint - Tilting the budget constraint - Taxes and the budget constraint - Quantity tax - Sales tax - Lump sum tax Page 1 Topic 5 Chapter 4 Budget Constraints Assume: There only 2 goods for a consumer to choose from: x1,x2 x1 is quantity of good 1 and x2 is quantity of good 2 - The amount of income the consumer has to spend = y - The prices of goods 1 and 2 are p1 and p2, respectively. Then we can say: p1x1 + p2x2 ≤ y Why? Is the assumption of 2 goods realistic? Yes. We can look at x1 as one good and x2 as a composite good of all other goods. Page 2 Topic 5 Shifts and Tilts of Budget Constraint Shifts x2 = y – p1x1 p2 p2 If y ↑ shift budget constraint out → y < y’ Notice slope doesn’t not change when y ↑. If you have more money, this does not change the price trade off between the 2 goods you buy. Page 5 Topic 5 Tilts If p1 or p2 ↓ or ↑ tilts the budget constraint Ex: p1 ↑ Recall: slope = -p1↑ → slope ↑ (becomes steeper) p2 Ex: p1 ↓ Ex: p2 ↑ Ex: p2 ↓ Page 6 Topic 5 Taxes and the Budget Constraint Types of Taxes: Quantity Tax → Per unit tax on each unit purchased. - acts like a price increase. Example: y = p1x1 + p2x2 → Budget constraint before the tax Quantity tax imposed on good 1 in the amount of t. Thus, the new price the consumer must pay for each unit of good 1 is (p1 + t). y = (p1 + t)x1 + p x2 → Budget constraint with tax x2 = y – (p1 + t)x1 → slope intercept form with tax p2 p2 What is the x1 intercept (when x2 = 0)? y = (p1 + t)x1 → x1 = y . p2 → x1 = y p2 p2 p2 ( p1 + t ) p1 + t Page 7