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?
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.
“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
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
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.
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
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)
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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