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Economics 310
Chapter 3: Budget Lines, Indifference Curves,
Demand and the Theory of Consumer
Choice.
Want a deeper understanding of the
economic forces underlying the
demand curve.
The plan for the remainder of the class is to look closer at the
economic forces underlying the supply and demand curves.
The demand curve shows how much of a good a person or group of
people will buy at any given price ceteris paribus (other things equal).
What happens when “other things” change.
 Income.
 Prices of related goods.
 Preferences.
 Taxes.
Want to be able to make positive statement like, “if income changes
then …..”
To answer these questions must take an in depth look at the economic
forces underlying the demand curve.
This is done using budget lines and indifference curves.
The Budget Constraint or Budget
Line
It shows the various combinations of
goods the consumer can afford given
his or her income and the prices of the
two goods.
The Budget Constraint
Pints of
Pepsi
0
50
100
150
200
250
300
350
400
450
500
Number of Spending on Spending on
Pizzas
Pepsi
Pizza
100
90
80
70
60
50
40
30
20
10
0
$ 0
100
200
300
400
500
600
700
800
900
1,000
$1,000
900
800
700
600
500
400
300
200
100
0
Total
Spending
$1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
The Budget Constraint Line
Any point on the budget constraint line
indicates the consumer’s combination or
tradeoff between two goods.
For example, if the consumer buys no pizzas,
he can afford 500 pints of Pepsi. If he buys
no Pepsi, he can afford 100 pizzas.
Alternately, the consumer can buy 50 pizzas
and 250 pints of Pepsi.
The Budget Constraint Line
Quantity
of Pepsi
500
250
0
50
100
Quantity
of Pizza
The Budget Constraint Line
Quantity
of Pepsi
500
B
250
0
50
A
100
Quantity
of Pizza
The Budget Constraint Line
Quantity
of Pepsi
500
B
250
Consumer’s
budget constraint
0
50
A
100
Quantity
of Pizza
The Budget Constraint Line
Quantity
of Pepsi
500
250
B
C
Consumer’s
budget constraint
0
50
A
100
Quantity
of Pizza
Two things to know about the
Budget Line.
The slope of the budget constraint line equals the relative price
of the two goods, that is, the price of one good compared to the
price of the other.
 It measures the rate at which the consumer will trade one
good for the other.
 The steeper the budget line the greater the relative price of
the good on the horizontal axis.
The position of the budget line represents income.
 The farther out the budget line on a ray from the origin, the
greater the income level it represents.
Budget Line Exercise (1); Draw 2 budget lines given the income
and prices below.
Budget Line Exercise (1) What is the slope of the red and purple
budget lines?
The slope of the budget line and relative price.
What does it mean in terms of relative
price of opportunity cost to say that
on the red budget line the relative
price is 5/2 and on the purple budget
line, the relative price is 5/8?
Which good, A or B, has a higher
relative price?
In order for a person to get more
good B, how much good A must the
give up for each extra unit of B the
get?
That amount is the relative price of
opportunity cost of B.
The slope of the budget line is the
relative price of the good on the
horizontal axis.
By definition the relative price of good
B is the amount of good A that must
be given up to get one more unit of
good B.
Practice Exam Question
Point A represents a bundle
that can be purchased with
$1000 whether the price of
goods A and B are $2 and
$5 or $ and $2.50.
A=166.67, B=133.33
Budget Line exercises
Suppose an individual has $500 of income. The price
of good A was $25 and the price of good B was $50.


Suppose someone gave you a non-transferable voucher for
10 units of good B, what will budget line look like?
Suppose someone gave you a coupon for B that said 2 for
the price of 1, limit free 3 units.
Advanced problem:

the McDonald’s Value Meal Problem. Suppose an individual
had $10. Big Macs cost $2 and fries cost $1. What does the
budget line look like. Suppose McDonald’s has a value meal
which includes a Big Mac and Fries for $2.50?
Suppose an individual has $500 of income. The price of
good A was $25 and the price of good B was $50.
Suppose someone gave you a coupon for B that
said 2 for the price of 1, limit free 3 units.
Advanced problem:the McDonald’s Value Meal Problem. Suppose an
individual had $10. Big Macs cost $2 and fries cost $1. What does the
budget line look like. Suppose McDonald’s has a value meal which
includes a Big Mac and Fries for $2.50?
Preferences:
What the Consumer Wants
A Budget Line shows the bundles of goods which are
attainable by an individual given his income and
prices.
A consumer’s preference among bundles of goods
may be illustrated with indifference curves.
An indifference curve shows bundles of goods that
leave the consumer equally satisfied.
 Show bundles of goods, where if the consumer
was given a choice between those bundles he
wouldn’t care which bundle he receives.
Indifference Curves
Quantity
of Pepsi
The consumer is indifferent, or
equally happy, with the
combination of goods shown at
points A, B, and C because they
are all on the same indifference
curve.
C
B
A
0
Indifference
curve, I1
Quantity
of Pizza
Two things to know about
Indifference Curves.
The slope at any point on an indifference curve is the marginal
rate of substitution.
 In the broadest terms, it the value of one unit of a good to a
person.
 In more technical terms, it is the rate at which a consumer is
willing to trade one good for another.
 It is the amount of one good that a consumer requires as
compensation to give up one unit of the other good.
 Ask the person, what is the minimum number of units of
the other good they must receive to get them to
voluntarily give up one unit of a good—that is the goods
marginal rate of substitution.
The Marginal Rate of
Substitution
Quantity
of Pepsi
MRS
1
Indifference
curve, I1
0
Quantity
of Pizza
Higher indifference curves are
preferred to lower ones.
The position of an indifference curve
represents satisfaction, utility or
happiness.
The farther out an IC from the origin
the happier the individual will be if he
can attain a bundle on that IC.
Indifference Curves
D is preferred to A, because at D
the person has more of both pepsi
and pizza.
Quantity
of Pepsi
C
D is preferred to C, because C is
equivalent to A and D is preferred
to A.
B
D
I2
A
0
Indifference
curve, I1
Quantity
of Pizza
Optimization: Predicting consumer
behavior.
Can use budget lines and indifference curves to generate
positive statements.
Using indifference curves and budget lines, the behavior of the
consumer can be stated in alternative but equivalent ways:



Choose the point on the budget line that is on the highest
indifference curve that has at least one point in common with the
budget line.
Choose the IC that is tangent to the BL.
Choose the bundle where the MRS equals the Relative Price.
 If the MRS < relative price, the person could be made happier by
consuming less of the good and more of the other good.
 If the MRS > relative price, the person could be made happier by
consuming more of the good and less of the other good.
The Consumer’s Optimal
Choice
Quantity
of Pepsi
I1
0
Quantity
of Pizza
The Consumer’s Optimal
Choice
Quantity
of Pepsi
I1
0
I2
Quantity
of Pizza
The Consumer’s Optimal
Choice
Quantity
of Pepsi
I3
I1
0
I2
Quantity
of Pizza
The Consumer’s Optimal
Choice
Quantity
of Pepsi
I3
I1
I2
Budget constraint
0
Quantity
of Pizza
The Consumer’s Optimal
Choice
Quantity
of Pepsi
Optimum
I3
I1
I2
Budget constraint
0
Quantity
of Pizza
MRS must equal relative price at the
optimum.
Quantity
of Pepsi
This consumer will not
choose this point because
with this bundle, the
MRS is less than the
relative price.
Explain.
Optimum
I3
I1
I2
Budget constraint
0
Quantity
of Pizza
MRS must equal relative price at the
optimum.
What is the slope of the
IC and BL at this point?
Quantity
of Pepsi
MRS=rise/run
Relative
Price=rise/run
Optimum
=2/4
=4/4
=1/2
=1
For each pizza the
taken
person
away,gives
the he
up,
person
can get
must
1 receive
pepsi. ½
pepsi to keep him just as well
off.
8
6
4
I1
I2
Budget constraint
0
6
10
Quantity
of Pizza
MRS must equal relative price at the
optimum.
If the person is consuming
Quantity
of Pepsi
Optimum
10 pizzas and 4 Pepsis, the
MRS<Relative Price.
½<1
MRS: If you took away 4
units of pizza and gave
him 2 units of Pepsi in
exchange the person’
happiness would be
unchanged.
8
6
4
I1
I2
Budget constraint
0
6
10
Quantity
of Pizza
MRS must equal relative price at the
optimum.
If the person is consuming
Quantity
of Pepsi
Optimum
10 pizzas and 4 Pepsis, the
MRS<Relative Price.
½<1
Relative Price of Pizza: If
the person gave up 4
pizzas, he could get 4
Pepsis.
8
6
4
I1
I2
Budget constraint
0
6
10
Quantity
of Pizza
MRS must equal relative price at the
optimum.
If the person is consuming
Quantity
of Pepsi
Optimum
If you take away 4 pizzas
and give him 2 Pepsis he
would be indifferent, but
if he game up 4 pizzas
I2
he could actually get 4
I1
Pepsis.
Budget constraint
8
6
4
0
10 pizzas and 4 Pepsis, the
MRS<Relative Price.
½<1
Why does moving to the
optimum make the
person better off?
6
10
Quantity
of Pizza
How a change in income will affect the bundle
of goods chosen by a person.
An increase in income shifts the budget
constraint outward.

The consumer is able to choose a better
combination of goods on a higher
indifference curve.
Changes in Income Affect
Consumer Choices
Changes in Income Affect
Consumer Choices
Quantity
of Pepsi
0
Quantity
of Pizza
Changes in Income Affect
Consumer Choices
Quantity
of Pepsi
I1
0
Quantity
of Pizza
Changes in Income Affect
Consumer Choices
Quantity
of Pepsi
I1
0
Quantity
of Pizza
Changes in Income Affect
Consumer Choices
Quantity
of Pepsi
New budget constraint
I1
0
Quantity
of Pizza
Changes in Income Affect
Consumer Choices
Quantity
of Pepsi
New budget constraint
I2
I1
0
Quantity
of Pizza
Changes in Income Affect
Consumer Choices
Quantity
of Pepsi
New budget constraint
New optimum
I2
I1
0
Quantity
of Pizza
Changes in Income Affect
Consumer Choices
Quantity
of Pepsi
New budget constraint
1. An increase in income shifts
the budget constraint outward…
New optimum
I2
I1
0
Quantity
of Pizza
Changes in Income Affect
Consumer Choices
Quantity
of Pepsi
New budget constraint
1. An increase in income shifts
the budget constraint outward…
New optimum
I2
I1
0
2. …raising pizza consumption…
Quantity
of Pizza
Changes in Income Affect
Consumer Choices
Quantity
of Pepsi
New budget constraint
1. An increase in income shifts
the budget constraint outward…
New optimum
3. …and Pepsi
consumption.
I2
I1
0
2. …raising pizza consumption…
Quantity
of Pizza
An increase in income can cause the
consumption of a good to increase or decrease.
If a consumer buys more of a good when his or her income
rises, the good is called a normal good.
If a consumer buys less of a good when his or her income rises,
the good is called an inferior good.
Consider the previous example. Are Pepsis and Pizzas normal or
inferior?
An Inferior Good
An Inferior Good
Quantity
of Pepsi
0
Quantity
of Pizza
An Inferior Good
Quantity
of Pepsi
I1
0
Quantity
of Pizza
An Inferior Good
Quantity
of Pepsi
Initial budget
constraint
I1
0
Quantity
of Pizza
An Inferior Good
Quantity
of Pepsi
Initial
optimum
Initial budget
constraint
I1
0
Quantity
of Pizza
An Inferior Good
Quantity
of Pepsi
New budget constraint
Initial
optimum
Initial budget
constraint
I1
0
Quantity
of Pizza
An Inferior Good
Quantity
of Pepsi
New budget constraint
Initial
optimum
Initial budget
constraint
I1
0
I2
Quantity
of Pizza
An Inferior Good
Quantity
of Pepsi
New budget constraint
Initial
optimum
New optimum
Initial budget
constraint
I1
0
I2
Quantity
of Pizza
An Inferior Good
Quantity
of Pepsi
New budget constraint
Initial
optimum
1. When an increase in income shifts
the budget constraint outward...
New optimum
Initial budget
constraint
I1
0
I2
Quantity
of Pizza
An Inferior Good
Quantity
of Pepsi
New budget constraint
Initial
optimum
1. When an increase in income shifts
the budget constraint outward...
New optimum
Initial budget
constraint
I1
I2
0
2. ... pizza consumption rises,
making pizza a normal good...
Quantity
of Pizza
An Inferior Good
Quantity
of Pepsi
3. ... but Pepsi
consumption
falls, making
Pepsi an
inferior good.
New budget constraint
Initial
optimum
1. When an increase in income shifts
the budget constraint outward...
New optimum
Initial budget
constraint
I1
I2
0
2. ... pizza consumption rises,
making pizza a normal good...
Quantity
of Pizza
How a change in price will affect the bundle of
goods chosen by a person.
A fall in the price of any good rotates the budget constraint outward
and changes the slope of the budget constraint.
Changes in Prices Affect
Consumer Choices
Quantity
of Pepsi
0
Quantity of Pizza
Changes in Prices Affect
Consumer Choices
Quantity
of Pepsi
500
I1
0
100
Quantity of Pizza
Changes in Prices Affect
Consumer Choices
Quantity
of Pepsi
500
Initial budget constraint
0
I1
100
Quantity of Pizza
Changes in Prices Affect
Consumer Choices
Quantity
of Pepsi
500
Initial optimum
Initial budget constraint
0
I1
100
Quantity of Pizza
Changes in Prices Affect
Consumer Choices
Quantity
of Pepsi
1. A fall in the price of Pepsi
rotates the budget constraint
outward…
500
Initial budget constraint
0
I1
100
Quantity of Pizza
Changes in Prices Affect
Consumer Choices
Quantity
of Pepsi
1,000
New budget constraint
1. A fall in the price of Pepsi
rotates the budget constraint
outward…
500
Initial budget constraint
0
I1
100
Quantity of Pizza
Changes in Prices Affect
Consumer Choices
Quantity
of Pepsi
1,000
New budget constraint
1. A fall in the price of Pepsi
rotates the budget constraint
outward…
500
Initial budget constraint
0
I1
100
I2
Quantity of Pizza
Changes in Prices Affect
Consumer Choices
Quantity
of Pepsi
1,000
New budget constraint
New optimum
1. A fall in the price of Pepsi
rotates the budget constraint
outward…
500
Initial budget constraint
0
I1
100
I2
Quantity of Pizza
Changes in Prices Affect
Consumer Choices
Quantity
of Pepsi
1,000
New budget constraint
New optimum
1. A fall in the price of Pepsi
rotates the budget constraint
outward…
500
Initial budget constraint
0
I1
I2
Quantity of Pizza
100
2. …reducing pizza consumption…
Changes in Prices Affect
Consumer Choices
Quantity
of Pepsi
1,000
New budget constraint
New optimum
1. A fall in the price of Pepsi
rotates the budget constraint
outward…
500
3. …and
raising Pepsi
consumption.
Initial budget constraint
0
I1
I2
Quantity of Pizza
100
2. …reducing pizza consumption…
Income and Substitution Effects
A price change causes a compound effect—
both the slope and position of the BL are
changed.

An income effect-change in the position of the BL.
 The income effect is the change in consumption that results
when a price change moves the consumer to a higher or
lower indifference curve.

A substitution effect-change in the slope of the BL.
 The substitution effect is the change in consumption that
results when a price change moves the consumer along an
indifference curve to a point with a different marginal rate
of substitution.
 When the price of a good increases, the amount of other
goods that must be given up increases.
Income and Substitution Effects
Quantity
of Pepsi
0
Quantity of Pizza
Income and Substitution Effects
Quantity
of Pepsi
Initial budget
constraint
I1
0
Quantity of Pizza
Income and Substitution Effects
Quantity
of Pepsi
Initial optimum
A
Initial budget
constraint
I1
0
Quantity of Pizza
Income and Substitution Effects
Quantity
of Pepsi
Initial optimum
A
Initial budget
constraint
I1
0
Quantity of Pizza
Income and Substitution Effects
Quantity
of Pepsi
B
Initial optimum
A
Initial budget
constraint
I1
0
Quantity of Pizza
Income and Substitution Effects
Quantity
of Pepsi
A price change first causes the
consumer to move from one point
on a indifference curve to another
on the same curve.
B
Substitution
effect
Initial optimum
A
Initial budget
constraint
I1
0
Quantity of Pizza
Substitution effect
Income and Substitution Effects
Quantity
of Pepsi
New budget constraint
B
Substitution
effect
Initial optimum
A
Initial budget
constraint
I1
0
Quantity of Pizza
Substitution effect
Income and Substitution Effects
Quantity
of Pepsi
New budget constraint
B
Substitution
effect
Initial optimum
A
Initial budget
constraint
I1
0
Quantity of Pizza
Substitution effect
Income and Substitution Effects
Quantity
of Pepsi
New budget constraint
B
Substitution
effect
Initial optimum
A
I2
Initial budget
constraint
I1
0
Quantity of Pizza
Substitution effect
Income and Substitution Effects
Quantity
of Pepsi
New budget constraint
C New optimum
B
Substitution
effect
Initial optimum
A
I2
Initial budget
constraint
I1
0
Quantity of Pizza
Substitution effect
Income and Substitution Effects
After moving from one point to another
on the same curve, the consumer
will move to another indifference curve.
Quantity
of Pepsi
New budget constraint
C New optimum
Income effect
B
Substitution
effect
Initial optimum
A
I2
Initial budget
constraint
I1
0
Quantity of Pizza
Substitution effect
Income effect
Practice Exam Question.
Draw budget lines and indifference
curves that show the effect of a price
change when one good is normal and
the other good is inferior.
Income and Substitution Effects: Inferior Good
Quantity
of Pepsi
0
Quantity of Pizza
Income and Substitution Effects: Inferior Good
Quantity
of Pepsi
Initial budget
constraint
I1
0
Quantity of Pizza
Income and Substitution Effects: Inferior Good
Quantity
of Pepsi
Initial optimum
A
Initial budget
constraint
I1
0
Quantity of Pizza
Income and Substitution Effects: Inferior Good--Substitution Effect
Quantity
of Pepsi
Initial optimum
A
Initial budget
constraint
I1
0
Quantity of Pizza
Income and Substitution Effects: Inferior Good--Substitution Effect
Quantity
of Pepsi
The Substitution Effect shows the effect of
the change in the relative price on the
combination of the two goods chosen.
It is derived by drawing a budget line with
a slope incorporating the new relative price
but tangent to the original indifference curve.
B
Initial optimum
A
Initial budget
constraint
I1
0
Quantity of Pizza
Income and Substitution Effects: Inferior Good--Substitution Effect
Quantity
of Pepsi
A price change first causes the
consumer to move from one point
on a indifference curve to another
on the same curve.
B
Substitution
effect
Initial optimum
A
Initial budget
constraint
I1
0
Quantity of Pizza
Substitution effect
Income and Substitution Effects: Inferior Good--Income Effect
Quantity
of Pepsi
New budget constraint
B
Substitution
effect
Initial optimum
A
Initial budget
constraint
I1
0
Quantity of Pizza
Substitution effect
Income and Substitution Effects: Inferior Good--Income Effect
Quantity
of Pepsi
New budget constraint
B
Substitution
effect
Initial optimum
A
Initial budget
constraint
I1
0
Quantity of Pizza
Substitution effect
Income and Substitution Effects
Quantity
of Pepsi
New budget constraint
B
Substitution
effect
Initial optimum
A
I2
Initial budget
constraint
I1
0
Quantity of Pizza
Substitution effect
Income and Substitution Effects: Inferior Good--Income Effect
Quantity
of Pepsi
New budget constraint
B
C
Substitution
effect
New optimum
A
Initial optimum
I2
Initial budget
constraint
I1
0
Quantity of Pizza
Substitution effect
Income and Substitution Effects: Inferior Good--Income Effect
Quantity
of Pepsi
New budget constraint
Pepsi is an inferior good because
the parallel shift outward of budget
line (income change) caused the
consumption of Pepsi to decline.
B
Income effect
Substitution
effect
Initial budget
constraint
A
C New optimum
Initial optimum
I2
I1
0
Quantity of Pizza
Substitution effect
Income effect
Deriving the Demand Curve
The demand curve shows the amount of a
good purchased by a person at different
prices.
Budget lines and indifference curves can be
used to show how a change in the price of a
good affects the amount purchased.
Budget lines and indifference curves can be
used to derive a person’s demand curve.
Deriving the Demand Curve:
The Consumer’s Optimum
Quantity
of Pepsi
The Demand Curve for Pepsi
Price of
Pepsi
New budget constraint
150
B
I2
50
A
At a price of $2,
the person buys 50
Pepsis.
$2
What would
happen if the price
of Pepsi fell to $1?
1
A
B
Demand
I1
0 Initial budget
constraint
Quantity
of Pizza
0
50
150 Quantity
of Pepsi
Budget Line and Indifference Curve
Analysis: Example 1.
Budget lines and indifference curves are flexible
analytical tools that can be used to analyze many
questions.
For instance, how do wages affect the supply of
labor?
 Question: can an increase in a person’s wage
make him work less?
If the substitution effect is greater than the income
effect for the worker, he or she works more.
If income effect is greater than the substitution
effect, he or she works less.
Setting up the problem: What goes on the axes?
Consumption
$5,000
Optimum
I 3
2,000
I 2
I 1
0
60
100
Hours of Leisure
Show indifference curves and budget lines for a person whose
supply curve is upward sloping, I.e. and increase in the wage
makes him work more hours.
(a) For a person with these
preferences…
Wage
Consumption
. . . the labor supply curve slopes upward.
1. When the
wage rises…
BC1
BC2 I2
I1
0
2. …hours of leisure
decrease…
Hour of
Leisure
0
Hours of Labor
Supplied
3. and hours of labor increase.
Show indifference curves and budget lines for a person whose
supply curve is upward sloping, I.e. and increase in the wage
makes him work more hours.
(a) For a person with these
preferences…
Consumption
BC1
. . . the labor supply curve slopes backward.
Wage
1. When the
wage rises…
BC2 I 2
I1
0
2. …hours of leisure
increase…
Hours of
Leisure
0
Hours of Labor
Supplied
3. and hours of labor decrease.
How do interest rates affect household saving—another
example of substitution and income effects.
If the substitution effect of a higher interest rate is greater than
the income effect, households save more.
If the income effect of a higher interest rate is greater than the
substitution effect, households save less.
Thus, an increase in the interest rate could either encourage or
discourage saving.
Consumption
when Old
Budget
constraint
What goes on the axes?
$110,000
55,000
Optimum
I1
0
$50,000
100,000
Consumption
when Young
(a) Higher Interest Rate
Raises Saving
Consumption
when Old
(b) Higher Interest Rate
Lowers Saving
Consumption
when Old
How will an increase
in interest rates affect
the BL?
0
0
Consumption
when Young
Practice Exam Question (Part 1): Show BL’s and IC’s that depict a
person who saves more when interest rates rise and a person
who saves less when interest rates rise.
(a) Higher Interest Rate
Raises Saving
Consumption
when Old
(b) Higher Interest Rate
Lowers Saving
Consumption
when Old
BC 2
BC 2
1. A higher interest rate
rotates the budget
constraint outward . . .
BC
1
1. A higher interest rate
rotates the budget
constraint outward . . .
BC1
I2
I1
0
2. . . . resulting in lower
consumption when young
and, thus, higher saving.
I
I
1
0
2. . . . resulting in higher
consumption when young
and, thus, lower saving.
2
Consumption
when Young
Practice Exam Question (Part 2): How can a the person in (b) be saving
less but have more Consumption When Old?
(a) Higher Interest Rate
Raises Saving
Consumption
when Old
(b) Higher Interest Rate
Lowers Saving
Consumption
when Old
BC 2
BC 2
Income
Effect
Income
BC
1
Effect
I2
I
I1
0
I
1
0
Practice Exam Question (Part 3): On which graph (a) or (b) is
Consumption when old an inferior good? Explain and show
graphically.
2
Consumption
when Young
Do the poor prefer to receive
cash or in-kind transfers?
Examples of in-kind transfers:

Food Stamps.

“Free” public schools.

Subsidized student loans.

Free college tuition.
If an in-kind transfer of a good forces the recipient to consume more of the
good than he would on his own, then the recipient prefers the cash transfer.
If the recipient does not consume more of the good than he would on his own,
then the cash and in-kind transfer have exactly the same effect on his
consumption and welfare.
It would always be better to give a poor person a cash transfer than an in-kind
transfer.
(a) The Constraint Is Not Binding
Cash Transfer
In-Kind Transfer
Food
Food
BC2 (with $1,000 cash)
BC
$1,000
0
1
B
A
BC2 (with $1,000 food stamps)
BC
1
I2
$1,000
I1
Nonfood
0
Consumption
B
I2
A
I1
Nonfood
Consumption
(a) The Constraint Is Not Binding
Cash Transfer
In-Kind Transfer
Food
BC2 (with $1,000 cash)
BC2 (with $1,000 food stamps)
Food
BC
1
$1,000
B
A
BC
1
I2
I2
$1,000
A
I1
0
B
I1
Nonfood 0
Consumption
Nonfood
Consumption
(b) The Constraint Is Binding
Cash Transfer
In-Kind Transfer
Food
BC 2 (with $1,000 cash)
BC 2 (with $1,000 food stamps)
Food
BC
BC
1
$1,000
C
$1,000
A
0
1
B
I1
A
I2
Nonfood 0
Consumption
B
I 1
I 3I 2
Nonfood
Consumption
First Exam.
Start reading Chapter 4.
Monday, October 2nd.
Covers Chapter 1-4 in Landsburg.
Homework due Friday.


Do only problems 4 and 5 to turn in on
Friday.
Do problems 8 and 9 for Wednesday's
lecture.