Ch4-slides - Chapter Four Consumer Choice Chapter Four...

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Consumer Choice Chapter Four Chapter Four
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Chapter Four Overview 1. Motivation 2. The Budget Constraint 3. Consumer Choice 4. Duality 5. Some Applications 6. Revealed Preference 1. Motivation 2. The Budget Constraint 3. Consumer Choice 4. Duality 5. Some Applications 6. Revealed Preference Chapter Four
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Consumer Expenditures, US, 2001 Yearly After Tax Income: $42,362 Yearly Total Expenditures: $40,900 Allocation of Spending Food $5,904 Housing $12,248 Transportation $8,672 Health care $2,239 Entertainment $1,958 Chapter Four Motivation
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• Price of x: P x ; Price of y: P y • Income: I Total expenditure on basket (X,Y): P x X + P y Y Assume only two goods available: X and Y The Basket is Affordable if total expenditure does not exceed total Income: P X X + P Y Y I P X X + P Y Y I Chapter Four The Budget Constraint
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P x X + P y Y = I Y = I/P y – (P x /P y )X Budget Set: • The set of baskets that are affordable Budget Constraint: • The set of baskets that the consumer may purchase given the limits of the available income. Budget Line: • The set of baskets that one can purchase when spending all available income. Chapter Four Key Definitions
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Two goods available: X and Y I = $10 P x = $1 P y = $2 Budget Line 1: 1X + 2Y = 10 Or Y = 5 – X/2 Budget Line 1: 1X + 2Y = 10 Or Y = 5 – X/2 Chapter Four A Budget Constraint Example
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I/P X = 10 Y X A C B I/P Y = 5 Budget line = BL 1 -P X /P Y = -1/2 If the price of X rises, the budget line gets steeper and the horizontal intercept shifts in If the price of X falls, the budget line gets flatter and the horizontal intercept shifts out Chapter Four A Budget Constraint Example
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Y X 10 5 BL 1 6 12 BL 2 I = $12 P X = $1 P Y = $2 Y = 6 - X/2 …. BL 2 If the price of X rises, the budget line gets steeper and the horizontal intercept shifts in If the price of X falls, the budget line gets flatter and the horizontal intercept shifts out Shift of a budget line Shift of a budget line Chapter Four A Budget Constraint Example
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Y X 5 6 I = $10 P X = $1 P Y = $3 Y = 3.33 - X/3 …. BL 2 BL 1 BL 2 3.33 10 If the price of X rises, the budget line gets steeper and the horizontal intercept shifts in If the price of X falls, the budget line gets flatter and the horizontal intercept shifts out Chapter Four Rotation of a budget line Rotation of a budget line A Budget Constraint Example
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Consumer’s Problem: Max U(X,Y) (X,Y) Subject to: P x X + P y Y < I Consumer’s Problem: Max U(X,Y) (X,Y) Subject to: P x X + P y Y < I Chapter Four Consumer Choice Assume: Î Only non-negative quantities Î "Rational” choice: The consumer chooses the basket that maximizes his satisfaction given the constraint that his budget imposes.
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Interior Optimum: The optimal consumption basket is at a point where the indifference curve is just tangent to the budget line.
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Ch4-slides - Chapter Four Consumer Choice Chapter Four...

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