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ECON 7030 Microeconomic Analysis
Lecture 1: Introduction
University of Queensland
Semester 1, 2023
Part I
Introduction to Microeconomic Analysis
What is Economics?
Economics is the study of
• Rational choices
• under constraints
• in interactive environments
Rationality
• In Economics, Rationality means Predictability
• It is the opposite to randomness
• It does not mean:
• Well-informed choices;
• Well-reasoned choices
• Unemotional choices; or
• Sensible choices
In What Sense are Choices Predictable?
• There are two approaches to thinking about non-random
choices:
1 Choices that can be explained by certain “criterion”
(Lectures 2–4)
2 Choices exhibit a certain kind of “regularities”
(Lecture 7)
• But, before that, we need to talk about what the consumer is
choosing from
Consumption Set
• We call the collection of choices that a consumer can
potentially care about the Consumption Set
• The consumption set does not have to do with consumption
in its strictest sense — it gets this name only because it’s
what a consumer (again, a very loose term) cares about
• Also, choices within the consumption set do not have to be
feasible or affordable
Consumption Bundles
• Consumption sets can be very general — it doesn’t have to be
about goods and services
• To fix ideas, though, we can think of Consumption Bundles
• A consumption bundle is simply a basket of goods and services
To Fix Ideas Further: A Two-Good World
• Baby’s world consists of only two kind of food: Pear and
Tomato
• A consumption bundle in baby’s world is therefore a bowl
containing certain amount of pear and certain amount of
tomato
• Notice that each bundle can be completely described by 2
numbers: the amount of pear and the amount of tomato in
that bundle
Table: Some Examples of Consumption Bundles
Pear (units) Tomato (units)
Bundle A (orange bowl) 1 2
Bundle B (green bowl) 3 1
Bundle C (blue bowl) 2 0
Bundle D (pink bowl) 1 3.1416
Consumption Bundles in a Two-Good
World
Pear
Tomato
A
B
C
D Pear Tomato
A 1 2
B 3 1
C 2 0
D 1 3.14
Notice that we are not plotting a graph — each point in the
graphing area is a bundle
For this course
• For this course, we will mainly work with a two-good world
with infinitely divisible goods
• This allows us to represent the consumption set on a
two-dimensional coordinate plane
• But you may ask:
1 How restrictive is a two-good world?
2 How restrictive is the perfect divisibility assumption?
Two Good: Too Few?
• Needless to say, there are more than two goods in this world
• However, if we are predominantly interested in the analysis of
the demand for one particular good (e.g., apple), then we can
consider a two-good world with apples (Good X ) and money
for all other goods (Good Y ) — in this sense it’s rather
flexible
• Most of the analysis we are going to see extend easily to more
than two goods, just that with more than two goods we can’t
use a graphical analysis but have to rely on mathematics
Perfect Divisibility: Unrealistic?
Good 1
Good 2
• When I claim that the whole positive quadrant is a
consumption set, I am assuming that you can subdivide goods
as fine as you want
• This assumption allows us to draw continuous lines, rather
than having to consider “integer points”
Divisibility and Flow Concepts
• Consumption (and demand, supply, etc.) are flow concepts —
they are measured in “units per time period” (an apple a day
is different from an apple a month)
• So suppose. . .
You Buy You Consume
3 pairs of shoes every year
1/4 pairs of shoes per month
1 fridge every 10 year
1/10 fridge per year
1 hair cut every 13 weeks
1/13 hair cut per week
• Divisibility simply means the frequency of purchase is different
from the time period
Constraints
• Unfortunately, we can’t always get what we like, that’s life
• We need to talk about constraints: what is feasible, or
affordable, to the consumer
Budget Set and Budget Line
• The budget set is the set of all bundles that are affordable to
the consumer
• The budget line is the collection of all bundles that exhaust
the consumer’s income
• The budget line is the frontier of the budget set
Budget Line: Example
• Alice consumes apples (Good X ) and bananas (Good Y )
• She is a price-taker (i.e., her consumption will not affect the
prices she face)
• The prices of the fruit are
Apples 2
Bananas 3
• Alice has an income of 12
Draw Alice’s Budget Line Here
Apples
Bananas
Apple Price = 2
Banana Price = 3
Income = 12
4
If Alice consumes no apples, she
can get 12/3 = 4 bananas
6
If Alice consumes no bananas, she
can get 12/2 = 6 apples
Alice sacrifices 2/3 banana
for each apple
slope = −2/3
Budget Line in General
Area under Budget Line is
the Budget Set
x
y
Price of x = Px
Price of y = Py
Income = M
M
Py
If no x is purchased, the consumer
can get M/Py units of y
M
Px
If no y is purchased, the consumer
can get M/Px units of x
The consumer sacrifices Px/Py
units of y for each unit of x
slope = −PxPy
Relative Price
• The slope of the budget line is given by the negative of the
Relative Price (of Good X to Good Y )
Slope of Budget Line = −Px
Py
=
∆y
∆x
• It measures the amount of Good Y that has to be given up
for an additional unit of Good X
• As only relative price matters, sometimes we normalise the
price of one of the goods (usually Good Y ) to 1 and measure
Px and M relative to it
• The good whose price is normalised is known as a numeraire
good
An Increase in Px
x
y
M
Py
slope = −PxPy
M
Px
M
P′x
slope = −P′xPy
• Suppose Px increases to P ′x
• The budget line pivots
• Notice that the set of affordable bundles becomes smaller
• For your exercise: How about an increase in Py?
An Increase in Income
x
y
M
Py
slope = −PxPy
M
Px
M′
Py
M′
Px
slope = −PxPy
• Suppose M increases to M ′
• The budget line shifts out parallely
• Notice that the set of affordable bundles becomes bigger
Summary
Consumption Set
• All that a consumer cares about
• Typically represented by a coordinate plane
Budget Set
• The part of the consumption set that is affordable to a
consumer
• Its frontier is known as the Budget Line
Next Lecture
• Using budget line to see whether choices “make sense” or
not