L5Choices - Introductionto Microeconomics Lecture5...

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1 Introduction to Microeconomics Lecture 5 Choices in Action Ian Crawford Review z Consumers choose the set of goods they most prefer, out of the set of goods they can afford. z We use utility functions/indifference curves to give formal content to “most prefer” z We use budget sets/constraints to give formal content to “can afford”. Review z In due course this becomes a constrained maximisation problem which you can solve mathematically “Maximise utility, subject to the budget constraint.” z So far you’ve learned how to solve the problem graphically for two goods . .. ( ) 12 1 1 2 2 , ,..., max , ,..., subject to ... n nn n xx x ux x x px px px m ++ +≤ Review x 2 Optimal choice ( ) * 2 * 1 , x x 0 x 1 * 1 x * 2 x Sub optimal choice #2 Sub optimal choice #1 Review z Given an indifference curve map you can change prices and income and work out the demands each time: { } { } ,, , ppm z Keep this up and you’ll map out the Marshallian Demand Functions { } { } {}{} , ˆˆ ˆ ˆ ˆ , %%% %% () ( ) 112 212 x ppm Outline z Properties of Marshallian Demands z Measuring changes elasticities z Income Changes z Price Changes z Decomposing price changes z Substitution and income effects z The Slutsky Equation z Modelling the labour supply (leisure demand) decision the Working Tax Credit [we may not get this far today]
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2 Measuring the Effects of Change – “Elasticities” z y depends upon x: z Change x a bit: z Look at the change in y ( ) yf x = ( ) x xx Δ= − yyy Δ y: z We could compare and to measure responsiveness, but the answer would depend on the units. z Economists use “elasticities” instead / Proportional change in The elasticity of : / Proportional change in yx yy y xy x ε Δ == Δ ( ) =− y Δ x Δ Measuring the Effects of Change – “Elasticities” Take a Marshallian demand function: 11 1 1 1 1 / The own price elasticity of demand : / xp x p pp px ΔΔ ( ) 112 ,, x ppm 12 1 1 2 22 2 1 1 1 / The cross price elasticity of demand : / / The income elasticity of demand : / xm x p mm mx x 2 Measuring the Effects of Change – Income Elasticities 1 /0 0 Δ> > 0 x 1 1 x Δ 2 x Δ 2 0 = => Both are “ Normal goods x 2 Measuring the Effects of Change – Income Elasticities 1 0 Δ< < x 1 0 1 x Δ 2 x Δ 2 0 > is a normal good Is an “Inferior Good” x 1 x 2 Measuring the Effects of Change – Income Elasticities “Necessities” “Luxuries” 0 1 i << 1 i < 0 Inferior Goods 1 Normal Goods Income Elasticities 0 i < 0 i > x 2 Measuring the Effects of Change – Price Elasticities The price of good 1 falls. Demand for good 1 rises x 1 0 1 x Δ 0 < Good 1 is an “Ordinary Good”
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3 x 2 Measuring the Effects of Change – Price Elasticities The price of good 1 falls. Demand for good 1 falls (!) x 1 0 1 x Δ 11 /0 0 xp xx pp ε Δ> == > Δ< Good 1 is a “Giffen Good” Measuring the Effects of Change – Own Price Elasticities Giffen “Price Elastic” “Price Inelastic” 1 ii < − 10 << 0 Ordinary Goods 1 Goods Own Price Elasticities 0 > 0 < x 2 Measuring the Effects of Change – Price Elasticities The price of good 1 falls. Demand for good 2 falls 22 0 > x 1 0 2 x Δ Goods 1 & 2 are “Substitutes” 21 x 2
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This note was uploaded on 04/12/2010 for the course ECON DEAM taught by Professor Vines during the Spring '10 term at Oxford University.

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L5Choices - Introductionto Microeconomics Lecture5...

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