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Lecture 13

# Lecture 13 - Announcements MT1 is a week from today E-mail...

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Announcements MT1 is a week from today. E-mail me if you have a conflict. Practice problems will be posted today. I recommend studying then using the problems as a practice exam. 1 of 40

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Utility Maximization Consumers want to maximize utility. They have to be within their budget set, but they want to be on the indifference curve that is farthest out (highest utility). So they should choose a point on the budget line that is tangent to the highest indifference curve that it hits. 2 of 40
Appendix 3 of 40 Consumer Utility-Maximizing Equilibrium CONSUMER CHOICE As long as indifference curves are convex to the origin, utility maximization will take place at the point at which the indifference curve is just tangent to the budget constraint. -

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Appendix Y Y X X P MU P MU = 4 of 40 Where two curves are tangent, they have the same slope, which implies that the slope of the indifference curve is exactly equal to the slope of the budget constraint at the point of tangency: By multiplying both sides of this equation by MU Y and dividing both sides by P X , we can rewrite this utility- maximizing rule as Y X Y X P P MU MU - = - slope of indifference curve = slope of budget constraint
Appendix 5 of 40 Deriving a Demand Curve from Indifference Curves and Budget Constraint DERIVING A DEMAND CURVE FROM INDIFFERENCE CURVES AND BUDGET CONSTRAINTS

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Price Changes Let’s talk a bit more about what happens when the price of a good that we buy changes (we’ve seen some of this before). 6 of 40
The Income and Substitution Effects of a Price Change When the price of one of the goods you buy changes, it has two separate effects on your consumption: 1.INCOME EFFECT 2.SUBSTITUTION EFFECT 7 of 40

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8 of 40 INCOME AND SUBSTITUTION EFFECTS THE INCOME EFFECT When the price of something we buy falls, we are better off . Our REAL INCOME (income in terms of what we can buy) rises as prices fall. As real income rises, we want to buy more of
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Lecture 13 - Announcements MT1 is a week from today E-mail...

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