ch04-Util_Max_pt2

# ch04-Util_Max_pt2 - Revealed Preference If (x*,y*) is...

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Revealed Preference • If (x*,y*) is chosen when (x’,y’) is available, we say that (x*,y*) is revealed preferred (x’,y’). • Often very helpful. You can never observe a person’s utility function, but you can observe her choices.

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The Lump Sum Principle • Taxes on an individual’s general purchasing power are superior to taxes on a specific good – an income tax allows the individual to decide freely how to allocate remaining income – a tax on a specific good will reduce an individual’s purchasing power and distort his choices
The Lump Sum Principle Quantity of x Quantity of y A U 1 • A tax on good x would shift the utility- maximizing choice from point A to point B B U 2

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• An income tax that collected the same amount would shift the budget constraint to I I The Lump Sum Principle Quantity of x Quantity of y A B U 1 U 2 Utility is maximized now at point C on U 3 U 3 C
Indirect Utility Function • It is often possible to manipulate first- order conditions to solve for optimal values of x 1 , x 2 ,…, x n • These optimal values will be x* n = x n ( p 1 , p 2 ,…, p n , I ) x* 1 = x 1 ( p 1 , p 2 ,…, p n , I ) x* 2 = x 2 ( p 1 , p 2 ,…, p n , I )

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Indirect Utility Function • We can use the optimal values of the x’ s to find the indirect utility function maximum utility = U ( x* 1 , x* 2 ,…, x* n ) maximum utility = V ( p 1 , p 2 ,…, p n , I )
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## This note was uploaded on 10/22/2009 for the course ECG 700 taught by Professor Morrill during the Fall '09 term at N.C. State.

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ch04-Util_Max_pt2 - Revealed Preference If (x*,y*) is...

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