Microeconomics

Academic Year 2020/21

Corso di Laurea in
Business and Economics (CLaBE)
Module Lecturer ‘consumer theory’
Matthew Wakefield

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Microeconomics

Matthew Wakefield

E-mail: matthew.wakefield (at) unibo.it

Office hour :
Given the current situation, office hours will
tend to be by appointment and online
using microsoft Teams.

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 Microeconomics

 Lecture times :
Thu, 11 - 14 Fri, 11 – 14 Total of 7 lectures
 You should know about use of presente.unibo.it to book
attendance

 Teaching materials:
Virtuale:
Go to my institutional website (sito web docente,
https://www.unibo.it/sitoweb/matthew.wakefield/en), click on the
tab for “teaching”, then on hyperlink to
“teaching resources on virtuale” under relevant course; you will
need unibo credentials
(email: [email protected], and password)

 Course Tutor: tbc

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Microeconomics

• Text book:
Hal R. Varian,
INTERMEDIATE MICROECONOMICS:
A Modern Approach
9th International Student Edition, 2014
W.W.Norton & Co., New York (& London),
ISBN: 978-0-393-92077-2

• Strongly recommended to have a copy

• Amazon; etc.

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 Microeconomics
Course Outline (provisional)
May be subject to some modification
Topics to be covered; (#) indicates relevant chapter in Varian
Bold indicates greater certainty that the topic will be covered.
1st part: Consumer Theory

I. Introduction VII.Demand (6)

II. Budget Constraint VIII. Slutsky Equation (8)
(2)
IX. Buying and Selling (9)
III. Preferences (3) [includes labour supply]
IV. Utility (4)
V. Choice (5) … Equilibrium ???

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Microeconomics
Lecture Timetable (Provisional)
May be subject to some modification

Timetable is Provisional
See: http://corsi.unibo.it/1cycle/EconomicsFinance/Pages/course-timetable.aspx

Week 1: 25/9
Week 2: 1/10, 2/10
Week 3: 8/10, 9/10
Week 4: 15/10, 16/10

… Prof Dragone …

•Notifications: studio.unibo email, and presente

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 Microeconomics
Module Aims
• Introduction to microeconomics, specifically consumer theory
• Preparatory for second module
• Preparatory for the exam (will see exam type exercises)
• Preparatory for other economics courses

• Provide an understanding of the principles and tools

of economic analysis
• Building and interpreting models
• Graphical and/or mathematical analysis where appropriate
• Analyse consequences of optimising behaviour

• Get you thinking as economists about everyday

phenomena – on which, another book:
Harford, Tim, (2006), The Undercover Economist,
London: Abacus, ISBN: 978-0-349-11985-4
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Microeconomics
Ground rules
• Follow CoVID protocols at all times!!!

• You will see material (theory) and exercises

• The responsibility for being on top of the material is
yours ...

• In lectures, I ask for quiet

• Don’t talk to your neighbours ...
• But you can interrupt with queries

• Following remotely: use the chat for queries

• Can potentially unmute and ask

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 Microeconomics

Academic Year 2020/21

Corso di Laurea in
Business and Economics (CLaBE)
Module Lecturer ‘consumer theory’
Matthew Wakefield

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 9/25/2020

Microeconomics
Part 1: Consumer Theory
True or false?
• When the price of a commodity falls, consumers will always
buy more of it.
• When prices fall, this makes a consumer better off.
• Taxes imposed on cigarettes and alcohol are proof that
Governments care about the health of citizens.
• The economics required to analyse labour-supply decisions is
very different from the economics required to analyse how
individuals make their spending decisions.
• Economists can help Governments design consumption taxes,
labour-income taxes, and benefit (transfer payment)
programs.

Consumer theory: much more detail on demand side than in

chapter 1 1

2 Budget Constraints

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Consumer theory in a nutshell

 Behind optimisation principle for consumer
 Consumer will choose the “best” bundle she
“can afford”
– Best? – ch 3 ff.
– Can afford? – this chapter
– Focus on financial constraints on what can
buy, there may be other constraints (e.g.
time).

Chapter 2
 Budget constraint, budget set
 Two goods are often enough
– Composite good $ (euro, £) spending on
 Drawing the budget line
 Interpretation: slope and opportunity cost
 Changes in the budget line
– And some conclusions about well-being
 Examples: Budget lines that are not straight

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Chapter 2
 Budget constraint, budget set
 Two goods are often enough
– Composite good $ (euro, £) spending on
 Drawing the budget line
 Interpretation: slope and opportunity cost
 Changes in the budget line
– And some conclusions about well-being
 Examples: Budget lines that are not straight

Budget Constraints: notation

 Consumption bundle: set of all items consumed, may
include more than one of any good
 Describe a consumption bundle by quantities of each
good consumed:
 Bundle containing x1 units of good (or service) 1, x2
units of good 2 and so on up to xn units of good n is
described by the vector (x1, x2, … , xn).
 Goods’ prices are p1, p2, … , pn.
 Let us suppose that the consumer has disposable
income m to allocate between the different goods

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Budget Constraints
 Q: When is a consumption bundle
(x1, … , xn) affordable at prices p1, … , pn?

 A: When
p 1x 1 + … + pnx n  m

 Expenditure no greater than disposable

income

Budget Constraints
p 1x 1 + … + pnx n  m

 The consumer’s Budget Constraint

 Choices must satisfy this constraint (inequality)
 (Quantities consumed must (usually) be non-
negative)
 All bundles that satisfy this constraint form the
consumer’s Budget Set

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Chapter 2
 Budget constraint, budget set
 Two goods are often enough
– Composite good $ (euro, £) spending on
 Drawing the budget line
 Interpretation: slope and opportunity cost
 Changes in the budget line
– And some conclusions about well-being
 Examples: Budget lines that are not straight

Budget Constraints
 Convenient to have 2 goods because (as will see) can
represent constraint on a 2-D graph
(more goods, more dimensions!)
 With 2 goods:
p1x1 + p2x2  m
 For many purposes, two goods are “enough”:
 Can consider good of interest (e.g. “food”) and
 Second good as composite: “all other things consumed”
 If define 1 unit of other stuff as $1 of spending, then:
p1x1 + x2  m
 Where food is good 1
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Chapter 2
 Budget constraint, budget set
 Two goods are often enough
– Composite good $ (euro, £) spending on
 Drawing the budget line
 Interpretation: slope and opportunity cost
 Changes in the budget line
– And some conclusions about well-being
 Examples: Budget lines that are not straight

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Budget Constraints
 Generally with 2 goods, 1 and 2.
Budget Constraint
p1x1 + p2x2  m

 If we consider this as an equation, we can also define

the budget line (bundles just affordable):
p1x1 + p2x2  m

 Which can be rearranged to

x2 = -(p1/p2)x1 + m/p2
 Drawing the budget line

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Budget Set and Constraint for

x2
Two Commodities
Budget line is
m /p2
p1x1 + p2x2 = m or
x2 = m/p2 - (p1/p2) x1

m /p1 x1

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Budget Constraints
 Generally with 2 goods, 1 and 2.
Budget Constraint
p1x1 + p2x2  m

 If we consider this as an equation, we can also define

the budget line (bundles just affordable):
p1x1 + p2x2  m

 Which can be rearranged to

x2 = -(p1/p2)x1 + m/p2
 Drawing the budget line
 Example: p1=2, p2=4, m = 20
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Budget Set and Constraint for

x2
Two Commodities
m /p2

m /p1 x1

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Budget Set and Constraint for

x2
Two Commodities
m /p2

Not affordable
Just affordable
Affordable

m /p1 x1

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Budget Set and Constraint for

x2
Two Commodities
Budget line is upper limit
m /p2 of budget set: just affordable

the collection
of all affordable bundles
Budget (includes budget line)
Set
m /p1 x1

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Chapter 2
 Budget constraint, budget set
 Two goods are often enough
– Composite good $ (euro, £) spending on
 Drawing the budget line
 Interpretation: slope and opportunity cost
 Changes in the budget line
– And some conclusions about well-being
 Examples: Budget lines that are not straight

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Interpretation of the Budget Line

Budget line is:

p1x1 + p2x2 = m
or: x2 = -(p1/p2)x1 + m/p2
so slope (gradient) is -p1/p2.
(Nb. This is for x1 on horizontal axis.)
What does this mean?
In terms of calculus, ∂x2 / ∂x1 = -p1/p2
• m (spending on the 2 goods) is constant along budget line, so gradient
is rate at which purchases of good 2 must change, in response to a
change in purchases of good 1, to keep total spending fixed
More intuitively …
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Interpretation of the Budget Line

 Suppose we define ∆x2 as the change in the quantity of good 2
that will just keep us on a given budget line after the quantity of
good 1 is increased by ∆x1.
- Note that ∆x2 will be negative
 What can we say about relationship between ∆x1 and ∆x2?
 If the budget line is for income (expenditure) level m, then:
p1x1 + p2x2 = m
and p1(x1 + ∆x1)+ p2(x2 + ∆x2) = m
 Subtracting these two equations from each other gives
p1∆x1 + p2∆x2 = 0
 Or rearranging: ∆x2 / ∆x1 = - p1 / p2
 So minus the ratio of the two prices is the rate at which the
commodities can be exchanged (on the market) without a
change in budget
 Graphically: 20

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Budget Constraints
x2 Equal but opposite change in
spending on each good:
p1∆x1 = - p2∆x2
Hence slope is
∆x1 ∆x2/ ∆x1 = -p1/p2

(x1 , x2)
∆x2
(x1+ ∆x1, x2+∆x2)

x1

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Interpretation of the Budget Line

∆x2 / ∆x1 = - p1 / p2
 Consider case where the change in the quantity of good 1 is 1:
 Then: ∆x2 = - p1 / p2
 Says if one extra unit of good one is bought, then (p1 / p2) fewer
units of good 2 must be bought if spending is to be held constant
- (Note that if quantity of good one had been reduced by 1,
then (p1 / p2) more units of good 2 could have been afforded).
 - p1 / p2 is the OPPORTUNITY COST of an extra unit of good 1, in
terms of units of good 2 that must be foregone
 Example: p1=2, p2=4
 Buying 1 extra unit of good 1 costs 2 euro
 From a given budget, this can be funded by giving up 0.5 (= 2/4)
units of good 2
 General case can be represented graphically:
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Budget Constraints
x2
Slope is -p1/p2

+1
-p1/p2

x1

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Budget Constraints
x2
Slope is -p1/p2
Opportunity cost of an
+1 extra unit of commodity 1 is
p1/p2 units foregone of
commodity 2. “Give up”
p1/p2 units of good 2 to
-p1/p2 “buy” extra unit of good 1.

x1

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Interpretation of the Budget Line

∆x2 / ∆x1 = - p1 / p2
 To get opportunity cost of good 2, need to set change in quantity of
good 2 to 1, then rearrange to get an expression for ∆x1
 This gives: ∆x1 = - p2 / p1
 Says if one extra unit of good 2 is bought, then (p2 / p1) fewer units
of good 1 must be bought if spending is to be held constant
 Example: p1=2, p2=4
 Buying 1 extra unit of good 2 costs 4 euro
 From a given budget, this can be funded by giving up 2 (= 4/2)
units of good 2
 Graphically:

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Budget Constraints
x2
Opportunity cost of an extra
unit of commodity 2 is
p2/p1 units foregone
+1 of commodity 1.

-p2/p1

x1

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Chapter 2
 Budget constraint, budget set
 Two goods are often enough
– Composite good $ (euro, £) spending on
 Drawing the budget line
 Interpretation: slope and opportunity cost
 Changes in the budget line
– And some conclusions about well-being
 Examples: Budget lines that are not straight

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Budget Sets & Constraints;

Income and Price Changes
 The budget constraint and budget set depend upon
prices and income. What happens as prices or
income change?

Key questions to answer

 What happens to intercepts? ((m/p1) and (m/p2))
 What happens to the slope? (- p1 / p2 )

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Budget Sets & Constraints;

Income and Price Changes
 First suppose that m increases, but prices remain
constant.

 Intercepts (m/p1) and (m/p2) both increase

 But prices and the price ratio (slope) are unchanged
 So …

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Higher income …
x2

Original
budget set
x1

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Higher income …
x2
… results in a parallel
outward shift in budget
constraint

Original
budget set
x1

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Budget Sets & Constraints;

Income and Price Changes
 First suppose that m increases, but prices remain
constant.

 Intercepts (m/p1) and (m/p2) both increase

 But prices and the price ratio (slope) are unchanged
 So …
 Example: p1=2, p2=4, m = 20, m’ = 28

 What about an income decrease?

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Budget Sets & Constraints;

Income and Price Changes
 Now suppose that 1 price falls, but income and the
other price are unchanged.
- Let p1 be the price that falls

 Intercept (m/p1) changes, other intercept does not

 Price ratio (p1/p2) gets smaller: slope less negative
 So …

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A reduction in price of good 1 …

x2
m/p2

-p1’/p2

Original
budget set
m/p1’ m/p1” x1

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A reduction in price of good 1 …

x2
m/p2 … causes budget line
to pivot outwards
-p1’/p2

Original
budget set
m/p1’ m/p1” x1

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Budget Sets & Constraints;

Income and Price Changes
 Now suppose that 1 price falls, but income and the
other price are unchanged.
- Let p1 be the price that falls

 Intercept (m/p1) changes, other intercept does not

 Price ratio (p1/p2) gets smaller: slope less negative
 So …
 Example: p1=2, p2=4, m = 20, p1’ = 1

 What about decrease in price of good 2? Price

increases?
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Chapter 2
 Budget constraint, budget set
 Two goods are often enough
– Composite good $ (euro, £) spending on
 Drawing the budget line
 Interpretation: slope and opportunity cost
 Changes in the budget line
– And some conclusions about well-being
 Examples: Budget lines that are not straight

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Some conclusions about well being

 Increase in income, or fall in at least one price (all else
unchanged):
 Leave all original bundles affordable
 And make some extra bundles affordable
 Thus agent is not forced to change choice
 Optimising agent will only change if this makes her better off
 So these changes CANNOT reduce welfare but can (usually
will) improve welfare
 (When price(s) fall, this makes a consumer better off
 Income falls and price rises reduce consumption possibilities
so can (generally will) reduce welfare

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Chapter 2
 Budget constraint, budget set
 Two goods are often enough
– Composite good $ (euro, £) spending on
 Drawing the budget line
 Interpretation: slope and opportunity cost
 Changes in the budget line
– And some conclusions about well-being
 Examples: Budget lines that are not straight

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Uniform Ad Valorem Sales Taxes

 An ad valorem sales tax levied at a rate of 5%
increases all prices by 5%, from p to
(1+005)p = 105p.
 An ad valorem sales tax levied at a rate of t
increases all prices by tp from p to (1+t)p.
 A uniform sales tax is applied uniformly to all
commodities.

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Uniform Ad Valorem Sales Taxes

 A uniform sales tax levied at rate t changes
the constraint from
p 1x 1 + p 2x 2 = m
to
(1+t)p1x1 + (1+t)p2x2 = m

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Uniform Ad Valorem Sales Taxes

 A uniform sales tax levied at rate t changes
the constraint from
p 1x 1 + p 2x 2 = m
to
(1+t)p1x1 + (1+t)p2x2 = m
i.e.
p1x1 + p2x2 = m/(1+t).
 So just like scaling income by a factor of
1/(1+t)

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Uniform Ad Valorem Sales Taxes

x2
m p1x1 + p2x2 = m
p2

m x1
p1
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Uniform Ad Valorem Sales Taxes

x2
m p1x1 + p2x2 = m
p2
m p1x1 + p2x2 = m/(1+t)
(1  t ) p2

m m x1
(1  t ) p1 p1
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Shapes of Budget Constraints

 Q: What makes a budget constraint a straight
line?
 A: constant slope (i.e. a straight line) when
prices are constants
 But what if prices are not constants?
 E.g. bulk buying discounts, (or price penalties
for buying “too much”).
 Then constraints will be kinked.

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Shapes of Budget Constraints -

Quantity Discounts
 Suppose p2 is constant at $1 but that p1=$2
for 0  x1  20 and p1=$1 for x1>20.
 Then the constraint’s slope is
- 2, for 0  x1  20
{
-p1/p2 =
- 1, for x1 > 20

and the constraint (with m = $100) is

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Shapes of Budget Constraints

with a Quantity Discount
x2 m = $100
100 Slope = - 2 / 1 = - 2
(p1=2, p2=1)

Slope = - 1/ 1 = - 1
(p1=1, p2=1)

20 50 80 x1

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Shapes of Budget Constraints

with a Quantity Discount
x2 m = $100
100 Slope = - 2 / 1 = - 2
(p1=2, p2=1)

Slope = - 1/ 1 = - 1
(p1=1, p2=1)

20 50 80 x1

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Shapes of Budget Constraints

with a Quantity Discount
x2 m = $100
100

Budget Constraint

Budget Set
20 50 80 x1

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Shapes of Budget Constraints

with a Quantity Penalty
x2

Budget
Constraint

Budget Set
x1

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The Food Stamp Program

 “Food stamps” are a real (US) welfare
program for low-income families
 Since 2008 “SNAP”: Supplemental Nutrition
Assistance Program
 Food stamps are coupons that can be legally
exchanged only for food.
 How does a commodity-specific gift such as a
food stamp alter a family’s budget constraint?

 See “exercises part 1”, slides 14 ff.

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Chapter 2: Summary
 Budget constraint, budget set
 Two goods are often enough
– Composite good $ (euro, £) spending on
 Drawing the budget line
 Interpretation: slope and opportunity cost
 Changes in the budget line
– And some conclusions about well-being
 Examples: Budget lines that are not straight

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2 Budget Constraints

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