ec 100 week 6. the budget set -feasible set defined by -given this income, maximise utility
TRANSCRIPT
![Page 1: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/1.jpg)
EC 100 Week 6
![Page 2: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/2.jpg)
The Budget Set- Feasible set defined by- Given this income, maximise utility
![Page 3: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/3.jpg)
Question 1• Suppose there are two goods and the price of good 2 rises. If we draw a
budget line with good one on the horizontal axis and good 2 on the vertical axis, how will the rise in the price of good 2 change the budget line.
• Price of good on vertical axis becomes more expensive --- so if you were to only purchase the good 2, then you could now purchase fewer units.
![Page 4: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/4.jpg)
Question 2
Why? Budget set does not change…
Bot left hand side (expenses on goods C1 and C2) goes up, but so do incomes.
![Page 5: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/5.jpg)
Question 3
• 10 units of Coke makes you as happy as 10 units of Pepsi.
• You would thus be willing to give up 1 unit of Coke in exchange for 1 unit Pepsi.
• No diminishing MRS
![Page 6: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/6.jpg)
Question 4
![Page 7: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/7.jpg)
Income Elasticity
Measures the responsiveness of your demand to a change in Income.Imagine the budget set being shifted out – by how much does your demand for Good 1 increase for a 1% increase in income?
![Page 8: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/8.jpg)
Question 5
If you consider the example of there being two goods (see graph) – what must happen to the demand for good2 if good 1 is a luxury good?
It either increases (but with an income elasticity < 1) or it decreases (in that case it is an inferior good)
![Page 9: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/9.jpg)
Question 6
![Page 10: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/10.jpg)
Question 7
![Page 11: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/11.jpg)
Question 8
• Suppose a consumer buys more of a good when his/her income rises. If the price of this good falls (keeping income and other prices constant) which of the following statements are true
• First statement: the good is a normal good with positive income elasticity.
• Second statement: holding prices and income constant…a lower price should induce consumers to demand more. The question just asks for the Substitution Effect.
![Page 12: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/12.jpg)
Question 9
• Increase tax: like a price increase
• Sub effect: reduce consumption• Income effect: increase consumption (inferior
good)• Net effect (sub + income effects) is ambiguous
![Page 13: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/13.jpg)
Question 9
• So…
Remember: Every Giffen good is an inferior good. However, not every inferior good is a Giffen good.
![Page 14: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/14.jpg)
Question 11
![Page 15: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/15.jpg)
Question 12
• Own Price Elasticity less than 1 means: a 1% increase in the price of the good reduces demand by less than 1%.
• So if you increase the price by 1% you cut back quantity by less than 1%, so total expenditure must rise.
![Page 16: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/16.jpg)
Question 13
![Page 17: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/17.jpg)
Discussion question
• Top tax rate rises from 40% to 50%• What happens to hours worked and tax
revenue?
![Page 18: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/18.jpg)
Without A TaxIncome
LeisureTotal time available
Hours of work
2000 hrs
150 k
![Page 19: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/19.jpg)
Tax on Income Above 150k?Income
Leisure
Hours of work
2000 hrs
150 k
New Budget
![Page 20: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/20.jpg)
• Below 2000 hours a year: The Work-Leisure choice is unaffected, as she is unaffected by the tax change
• Above 2000 hours a year :– Remember: leisure is a good to consume (labour is
its alternative)– When wage falls:– Substitution effect: more leisure (unambiguous)– Income effect: income falls, so• Consume less leisure if it is normal• Consume more leisure if it is inferior
![Page 21: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/21.jpg)
Somebody earning more than 150kIncome
LeisureTotal time available
2000 hrs
150 k
![Page 22: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/22.jpg)
Somebody earning more than 150kIncome
LeisureTotal time available
2000 hrs
150 k
As drawn, leisure increases (so hours worked falls)
![Page 23: EC 100 Week 6. The Budget Set -Feasible set defined by -Given this income, maximise utility](https://reader030.vdocuments.us/reader030/viewer/2022032723/56649d0f5503460f949e52be/html5/thumbnails/23.jpg)
How is the relationship between Tax Rates and Tax Revenues?
• There is an “inverse U shaped” relationship between tax rates and tax revenues.
• This is called the “Laffer Curve”– Linked to the idea of backward-bending labour
supply curve
• Can people really substitute out of labour so easily?