Choice and Resource Allocation under Scarcity

• What is constrained optimisation?

  method of finding the best possible outcome under given limitations or restrictions
• what is constrained optimisation used for?

  to maximise output or utility whilst minimising costs/ expenditure
• what is economics about?

  analysing constrained optimisation- i.e. choice
• what are critical restraints?

  factors that limit economic growth and development of a firm
• why is income a critical restraint?

  because it's usually limited
• what are some examples of critical restraints?

  - income

  - resources

  - inflation
• what are some problems of optimisation?

  - too little info

  - neglected info

  - bias income + budget constraints
• what is the budget constraint?

  - the total amount of items you can afford within a current budget

  - having to make choices based on income

  - total consumption is limited by income
• How do you analyse the budget constraint?

  - consider choice between one good (x) and all other goods (y)

  - total consumption (c) consists of some combinations of x and y: c=f(x ,y)

  - need budget

  - need price of x

  - need price of other good

  -can plot on diagram
• what does the budget line show?

  all possible combinations of x and y
• draw a diagram to show the budget constraint?

  
• how do people decide what combination of x and y to buy with their budget?

  - depends on their preferences

  - people choose their own personal combos (links to opportunity cost)
• how do you calculate the slope of the budget constraint?

  change in vertical distance/ change in horizontal distance
• what is the income effect?

  -income changes consumption which moves the budget line

  - the impact of change in income on consumption
• What happens to the budget line if income rises?

  the budget line moves parallel outwards
• what happens to the budget line if income falls?

  the budget line moves parallel inwards (towards origin)
• why does the budget line only shift parallel when income changes?

  because the prices haven't changed so the slope remains the same
• what happens to consumption when:

  1) income rises

  2) income falls

  1) increase consumption of both x and y

  2) decreases consumption of both x and y ( generally, not always)
• What is the substitution effect?


  consumption of both goods will change if price of one good changes (alters budget line slope)
• why does a change in a price of a good alter the budget constraint slope?


  the relative price of x and y has changed
• if price of good x falls what happens to the budget line slope?

  it will pivot outwards (the gradient will change)
• what are the 2 effects of a change in the price relationship between goods x and y?

  1) consumption of good with relative price fall is expected to increase- more for budget

  2) consumption of other good expected to fall even though the price has not changed - now relatively more expensive.