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DISCUSSION SECTION 3
Choice
A decision maker chooses its most preferred alternative from the affordable ones.
Two conditions for optimality (wellbehaved 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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 Spring '08
 Hansen
 Microeconomics

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