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Unformatted text preview: ECO 200: Microeconomic Theory Lecture notes on Consumer Theory 1 Fall 2009 Carlos J. Serrano 1 Lecture notes updated on Sept. 10, 2009 at 10.35am. 1 1 Consumer Theory Summary Consumer preferences. Axioms of choice IndiFerence curves Utility function Marginal rate of substitution Consumer choice Budget set and budget line Optimal consumption bundle Demand Individual demand What are the eFects of the change in the price of a good: income and substitution eFect? What are the eFects of a change in income? Market demand, elasticities and network externalities Revealed preference 2 1.1 Consumer preferences Elements of a decision problem (1. consumption set, 2. consumption bundle and 3. pref erence relation). The starting point for any decision problem is a set of possible (mutually exclusive) alternatives from which individuals must choose. We denote this set by X . For the time being, this set can be anything. For instance, X = {going to work, go to college, become a soccer player}; or X = { x R 2 + } , where x is a vector of 2 components representing the number of units of food and clothes that you might consume. Consequently, we will generally denote X as the consumption set. DeFnition 1 A consumption set is the set of possible (mutually exclusive) alternatives from which individuals must choose. We will denote as a consumption bundle or basket every alternative in the consumption set. DeFnition 2 A basket or a bundle is a collection of goods and services than an individual might consume. Example: x = (2 , 4) i.e., 2 units of food and 4 units of clothing; y = (1 , 1); z = (5 , 1); r = (3 , 1); s = (1 , 5) . We can generalize these examples allowing for bundles with N components, where N can be very large. For simplicity we will use N = 2 . The next element dening an individual decision problem are the decision makers tastes, or preference relations . In our approach to modelling the process of individual decision choice the preference relations are the primitive characteristic of the individual. DeFnition 3 A preference relation, denoted by f , is an indication of how a consumer would rank two possible baskets. We read x f y as " x is at least as good as y ". From f we can obtain two other important relation on the consumption set X. (i) Strict preference relation, F , dened by x F y if and only if x f y but not y f x. We read x F y as " x is stricly preferred to y ". (ii) The indierence relation, , dened by x y if and ony if x f y and y f x. We read x y as " x is indierent to y ". 3 Note that every binary relation, like a preference relation, is an ordinal preference relationship. In an ordinal preference order, we can rank elements but we cannot tell "the amount by which I like more a bundle than another one"....
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 Spring '10
 CarlosSerrano
 Microeconomics, Utility

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