Microeconomic Theory

Microeconomic Theory - UNIT I: Theory of the Consumer...

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UNIT I:Theory of the Consumer Introduction: What is Microeconomics? Theory of the Consumer 9/24
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Theory of the Consumer Preferences Indifference Curves Utility Functions Optimization How do they respond to changes in prices and income? How do consumers make optimal choices?
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We said last time that microeconomics is built on the assumption that a rational consumer will attempt to maximize (expected) utility. But what is utility? Over time, economists have moved away from a notion of cardinal utility (an objective, measurable scale, e.g., height, weight) and toward ordinal utility, built up from a simple binary relation, preference. Theory of the Consumer
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We start by assuming that a rational individual can always compare any 2 alternatives (“consumption bundles” or “market baskets”). We call this basic relationship preference : For any pair of alternatives, A and B, either A > B A is preferred to B A < B B is preferred to A A = B Indifference Preferences e.g., 2 apples & 3 oranges.
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“Well-behaved” preferences are (i) Connected: For all A & B, either A>B; B>A; A=B (ii) Transitive: If A > B & B > C, then A > C (iii) Monotonic: More is always preferred to less ( free-disposition ) (iv) Convex: Combinations are preferred to extremes Preferences
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Preferences Y X A B 3 2 2 3 A = ( 2 , 3 ) B = ( 3 , 2 ) A ? B
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Preferences Y X A B Y a Y b X a X b A = (Xa, Ya) B = (Xb, Yb) A ? B What can we say about the relationship between A and B?
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Preferences Y X A C B Y a Y b X a X b A = (Xa, Ya) B = (Xb, Yb) C = (Xb, Ya) A ? B C > A C > B What can we say about the relationship between A and B? Now consider point C
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Preferences Y X A C B Y a Y b X a X b A = (Xa, Ya) B = (Xb, Yb) C = (Xb, Ya) A = B = E D > E D > B D > A D E Indifference curves Now consider point D and E
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Indifference Curves Y X 3 2 2 3 Generally, ICs are : Downward sloping Convex to origin Inc utility, further from origin Cannot cross U = XY Indifference Curve: The locus of points at which a consumer is equally well- off, U.
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Indifference Curves Y X 3 2 2 3 Generally, ICs are : Downward sloping Convex to origin Inc utility, further from origin Cannot cross U = 9 U = 6 U = 4 U = XY
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Indifference Curves Y X 3 2 2 3 Generally, ICs are : Downward sloping Convex to origin Inc utility, further from origin Cannot cross A = B; A = C; B > C !! U = XY A B C
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Indifference Curves Perfect Substitutes Perfect Complements
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Utility Functions X U Assume 1 Good: U = 2X Utility: The total amount of satisfaction one enjoys from a given level of consumption (X,Y)
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X U Assume 1 Good: X U U = 2X MUx = U/ X = 2 Marginal Utility: The amount by which utility increases when consumption (of good X) increases. MUx =
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This note was uploaded on 12/09/2009 for the course ECON 1010 taught by Professor Neugeboren during the Fall '09 term at Harvard.

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Microeconomic Theory - UNIT I: Theory of the Consumer...

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