lecture03 - PREFERENCES AND UTILITY Fundamental Problem of...

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PREFERENCES AND UTILITY Fundamental Problem of Micro-Economics : satisfying unlimited wants with scarce resources What a consumer wants (preferences) => What a consumer actually consumes (choice) What a consumer can afford (budget) The Approach : perfectly-rational consumers pursuing their self interest
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RATIONAL BEHAVIOR THREE KEY ASSUMPTIONS Consumer can make a decision (“completeness”) Either a preferred to b , or b preferred to a , or indifferent between the two: Consumer is consistent (“transitivity”) If a preferred to b , and b preferred to c , then a preferred to c: Consumer prefers more to less (“monotonicity”) If a has more of all goods than b , then a is preferred to b : or or ~ a b b a a b f f % % if and , then a b b c a c f f f % % % if and , then a b a b X X Y Y a b f % f %
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Rational Behavior? Limitation of homo economicus Transitivity experiments Biases caused by “anchoring,” status quo, regret, “halo” effects Interdependencies One consumer’s preferences depend on how another ranks bundles, or on their consumption (bandwagon, snob effects) Habit formation A consumer’s preferences depend on how much of the good they consumed in the past
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The Indifference Curve All bundles among which a consumer is indifferent “Indifference map” is all of a consumer’s indifference curves – All bundles (X a , Y a ) such that: (X a , Y a ) ~ (X 0 , Y 0 )
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Properties of Indifference Curves 1. Every bundle is on some indifference curve 2. Two indifference curves never cross 3. An indifference curve is not “thick” 4. Indifference curve slopes downward 4. a bundle that has more of all goods is on a higher indifference curve (“no satiation”)
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Properties of Indifference Curves
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Marginal Rate of Substitution Question How much more of a good (e.g., Y) would a consumer require to compensate them for loss of a unit of another good (e.g., X) Measurement MRS measures willingness to make this substitution: XY MRS dY dX = -
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This note was uploaded on 08/01/2008 for the course ECON 100A taught by Professor Woroch during the Spring '08 term at University of California, Berkeley.

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lecture03 - PREFERENCES AND UTILITY Fundamental Problem of...

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