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Ch5_class_09

# Ch5_class_09 - Chapter Five Choice Economic Rationality The...

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Chapter Five Choice

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Economic Rationality The principal behavioral postulate is that a decisionmaker chooses its most preferred alternative from those available to it. The available choices constitute the choice set. How is the most preferred bundle in the choice set located?
Choice Problem Given utility function given prices p 1 , p 2 , and income m, the consumer chooses a bundle to maximize subject to budget constraint: Max subject to U(x 1 ,x 2 ), U(x 1 ,x 2 ) p 1 x 1 + p 2 x 2 = m. U(x 1 ,x 2 ) p 1 x 1 + p 2 x 2 = m

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Optimal Choice Affordable bundles x 1 x 2 More preferred bundles
Optimal Choice x 1 x 2 x 1 * x 2 * (x 1 *,x 2 *) is the most preferred affordable bundle. Intuition?

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Ordinary Demand The most preferred affordable bundle is called the consumer’s ORDINARY DEMAND at the given prices and income. Ordinary demands for goods will be denoted by x 1 *(p 1 ,p 2 ,m) and x 2 *(p 1 ,p 2 ,m).
Interior Optimal Bundle When x 1 * > 0 and x 2 * > 0, the demanded bundle is INTERIOR .

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