Welcome to the next section following a discussion on utility and indifference curves (preferences of consumers). We are now into a discussion on demand theory; the previous posts are linked chronologically at the bottom of this post.
Demand theory wants to explore the concept of: given constraints we must make choices among competing alternatives.
Budget Constraint in formulaic expression:
Relative Prices: P1/P2:
1. Opportunity cost of good 1 in terms of good 2.
2. Absolute value of the budget line slope.
3. Rate at which good two (2) can be substituted for good 1.
Here’s an example:
X1 = 10, P1 = 5
X2 = 15, P2 = 5
Budget line, X1p1 + X2p2 = m
M = 125
X2 intersect = x1 = 0 = m/P2 = 125/5 = 25
X1 intersect = x2 = 0 = m/P1 = 125/5 = 25
Slope = 5/5 = p1/p2 = 1