disc3 - DISCUSSION SECTION 3 Choice A decision maker...

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DISCUSSION SECTION 3 Choice A decision maker chooses its most preferred alternative from the affordable ones. Two conditions for optimality (well-behaved preferences): 1. The budget is exhausted: p 1 x 1 * +p 2 x 2 * =m 2. The slope of the budget constraint and of the indifference curve coincide: 2 , 1 2 1 MRS P P = . Two equations and two unknowns! ------------------------------------------------------------------------------------------------------------ QUESTION 1 This is the same question as question 4 in the previous handout. Alicia likes watching DVDs (x 1 ) and listening to her favorite CDs (x 2 ). Her utility function is given by U (x 1 , x 2 ) = (x 1 ) 3 (x 2 ) 1 . From part (a) we have 1 2 2 , 1 3 x x MRS = . From part (b), Alicia’s MRS at (1,1) is 3 and we depict it as the slope of the indifference curve at (1,1). c) Let the price of a DVD be $40 and the price of a CD be $20, and Alicia’s income be $800. Write down the (two) conditions that guarantee the optimality of her choice. Illustrate them on the graph.
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disc3 - DISCUSSION SECTION 3 Choice A decision maker...

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