lecture04 - CONSUMER CHOICE: "Utility Maximization...

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CONSUMER CHOICE: Utility Maximization Subject to a Budget Constraint” or “Budget Line Meets Indifference Curves” Rational consumer approach: highest utility money can buy! Max X,Y U(X,Y) subject to: p X *X + p Y *Y < Solution: Move out to highest indifference curve without breaking the budget Optimum bundle where an indifference curve is tangent to budget line: MRS = p X / p Y Results presumes both goods are purchased I
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CONSUMER CHOICE Recall that: MRS = - dY /dX = MUX / MUY slope of BL = dY /dX = - p X /p Y Substituting, we get a condition for the optimum bundle: MU X / MU Y = p X /p Y Interpreting the Optimum Condition Rearrange optimum condition: MU X / p X = MU Y /p Y MU X (1/p X ) gives the utility of last dollar spent on music Last dollar spent on music increases utility the same amount as the last dollar spent on movies!
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CONSUMER CHOICE (Cont’d) Corner Solution “MRS = price ratio” does not hold anywhere along budget line for
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lecture04 - CONSUMER CHOICE: &quot;Utility Maximization...

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