Exercise 1
BUDGET CONSTRAINT

I. Objectives

• To sketch the budget constraint, given prices and income
• To understand how changes in price and income affect the budget constraint

II. Data

• The equation for the budget constraint is: P₁Q₁ + P₂Q₂ = Y,
  where P₁ is the price of Good 1, P₂ is the price of Good 2, Q₁ is the quantity of Good 1, Q₂ is the quantity of Good 2, and Y is the consumer's income.
• Choose values for the parameters (prices and income).
• Sketch the budget constraint. Indicate the intercepts and slope. [Plot Good 1 (Q₁) on the horizontal axis.]
• Click on Gimme Budget Constraint! to confirm your calculations.

III. Questions

1. Choose values for prices and income. Sketch the corresponding budget constraint. Indicate the intercepts and slope.
   [Note: Slope equals -P₁/P₂.]

2. "An increase in P₁ will cause the horizontal intercept to rise and the budget constraint to rotate outwards." Anything wrong with the statement? Provide a sketch.

3. A decrease in consumer's income will cause both intercepts to [ rise / fall ] and the slope of the budget constraint to
   [ increase / decrease / remain unchanged ]. Sketch.

4. If Good 2 becomes cheaper, the vertical intercept will [ increase / decrease / stay the same ] and the budget constraint will become [ steeper / flatter ]. Sketch.