lecture 17-demand-indifference - Indifference Analysis...

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©2007 John M. Abowd and Jennifer P. Wissink Micro Indifference Analysis Prof. John M. Abowd October 24, 2007
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©2007 John M. Abowd and Jennifer P. Wissink Micro Important Reminders Chapter 10 and 11 required problem sets due Friday. Excel problem set 2 due Tuesday, October 30. Prelim 2 is Thursday, November 1 at 7:30pm. If you have a conflict or special requirements, follow the instructions on the course web page (under Grading). You must provide this information by tomorrow, October 25. Coverage: lectures 11-19, chapters 8-11, taxes and welfare experiment, Excel problem set 2. Review sessions: Sunday October 28, 8:30-10:00pm PS 233. Monday October 29, 3:00-4:30pm MT Bache Aud. The sessions are identical.
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©2007 John M. Abowd and Jennifer P. Wissink Micro Themes of Today’s Lecture More about the budget constraint Preference properties reviewed Derivation of the individual demand curve from the budget constraint and indifference curves Income and substitution effects
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©2007 John M. Abowd and Jennifer P. Wissink Micro Graph of Maryclaire’s Budget Constraint The graph to the right shows a picture of Maryclaire’s budget constraint. Each blue diamond is a point from the table. The slope is equal to -2 , as shown on the last slide ( ERS = 2 ) Maryclaire's Budget Constraint 0 5 10 15 20 25 30 35 40 0 1 2 3 4 5 6 7 8 9 10 Beans Carrots
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©2007 John M. Abowd and Jennifer P. Wissink Micro Maryclaire Faces New Prices Now, suppose that the price of beans remains at $4/lb. and the price of carrots falls to $1/lb. The purple squares show the new budget constraint. Notice that the slope is now -4/1 = -4 ( ERS = 4 ) Maryclaire's Budget Constraint 0 5 10 15 20 25 30 35 40 0 1 2 3 4 5 6 7 8 9 10 Beans Carrots
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©2007 John M. Abowd and Jennifer P. Wissink Micro Maryclaire All New Prices and Income Now, suppose that: Income = 2 x $40 = $80 . PB = 2 x $4/lb = $8/lb . PC = 2 x $2/lb = $4/lb . The purple squares show the new budget constraint. Maryclaire is right back where she started ( ERS = 2 ). Maryclaire's Budget Constraint 0 5 10 15 20 25 30 35 40 0 1 2 3 4 5 6 7 8 9 10 Beans Carrots
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©2007 John M. Abowd and Jennifer P. Wissink Micro Budget Line Gymnastics What have we done with the budget constraint: An increase in income only. An decrease in the price of beans only. An decrease in the price of carrots only. Income doubles as do the prices of beans and carrots. Maryclaire’s “real income” has not changed. Real income increases when the budget line moves right (out). Real income decreases when the budget line moves left (in). Changes in the price of beans relative to the price of carrots change the ERS, the slope of the budget line.
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©2007 John M. Abowd and Jennifer P. Wissink Micro Utility and Preferences Utility is the way economists measure preferences.
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lecture 17-demand-indifference - Indifference Analysis...

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