Lesson 2

Question 1

What is a key geometric property of a budget constraint?

Answer 1

It can be rearranged to form a line.

Question 2

What fundamental economic information does the budget line provide about goods x1 and x2?

Answer 2

It indicates how much x1 and x2 can be bound (i.e., the maximum attainable combinations given the budget).

Question 3

What is the economic interpretation of the vertical intercept (m/p2) of the budget line?

Answer 3

It is the maximum quantity of good x2 that can be purchased if all income (m) is spent on it.

Question 4

What is the economic interpretation of the horizontal intercept (m/p1) of the budget line?

Answer 4

It tells how many units of x1 should be consumed (i.e., the maximum quantity) if the entire budget (m) is spent on x1 while consuming zero units of x2.

Question 5

What are the two main categories of government policies that affect the consumer’s budget line?

Answer 5

Tax and Subsidy.

Question 6

Within the “tax” category, what two specific types are mentioned?

Answer 6

Quantity tax and Ad valorem tax.

Question 7

Within the “subsidy” category, what two specific types are mentioned?

Answer 7

Subsidy (implied quantity) and Ad valorem subsidy. There is also a separate “lump-sum” subsidy.

Question 8

How does a quantity tax directly alter the effective price of a good for the consumer?

Answer 8

The price becomes (p + t), where ‘t’ is the per-unit tax amount.

Question 9

How does an ad valorem tax directly alter the effective price of a good for the consumer?

Answer 9

The price becomes (1 + τ)p, where ‘τ’ (tau) is the tax rate.

Question 10

How does a quantity subsidy directly alter the effective price of a good for the consumer?

Answer 10

The price becomes (p - s), where ‘s’ is the per-unit subsidy amount.

Question 11

How does an ad valorem subsidy directly alter the effective price of a good for the consumer?

Answer 11

The price becomes (1 - σ)p, where ‘σ’ (sigma) is the subsidy rate.

Question 12

What is a “lump-sum” subsidy or tax, and how does it affect the budget constraint?

Answer 12

It is a direct transfer (u) that changes income. The budget becomes m + u (where u is positive for a subsidy and negative for a tax).

Question 13

In the context of a specific tax policy, what do the notations x̄ (x-bar) or ȳ (y-bar) represent?

Answer 13

They represent a specific, fixed “without tax” quantity of a good.

Question 14

How is the budget line graphically affected when a tax is applied only to consumption beyond a specific quantity like x̄ or ȳ?

Answer 14

The graph is “sliced”; it has a kink at the point (x̄, ȳ). Up to that point, the original prices apply; beyond it, the tax-inclusive prices apply.

Question 15

What is the economic interpretation of the “sliced” or kinked budget line with a tax beyond x̄ and ȳ?

Answer 15

The graph is pivoted at the kink to show that only consumption in excess of the x̄ and y-bar allowances is subject to the tax.

Question 16

What is the formula for the slope of the standard budget line, and what does it represent?

Answer 16

The slope is -p1/p2. It represents the market’s trade-off or opportunity cost of good 1 in terms of good 2.

Question 17

If a quantity tax ‘t’ is applied to good 1, what is the new formula for the slope of the budget line?

Answer 17

The slope becomes -(p1 + t)/p2.

Question 18

What happens to the position of the budget line when income (m) increases while prices (p1, p2) remain unchanged?

Answer 18

The budget line shifts outward (away from the origin) in a parallel manner.

Question 19

In general, what economic variables cause the slope and intercepts of the budget line to change?

Answer 19

They change depending on m (income) and p (prices).

Question 20

What specific change occurs to the budget line when prices change but income (m) remains the same?

Answer 20

If m is the same and a price changes, the budget line shifts (it pivots around the intercept of the good whose price did not change).

Question 21

What is the economic purpose and meaning of designating a numeraire good?

Answer 21

It is to set the price of one good to 1 (or a constant) to simplify analysis, allowing for a better assessment of the relationship between other variables (like quantities of other goods, income) in relation to prices or income.