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ECON191 Tutorial - ECON191(Spring 2010 22 25...

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1 ECON191 (Spring 2010) 22, 25 & 26.2.2010 (Tutorial 2) Chapter 2 Theory of Consumer (Chapter 3 Consumer Behavior) Consumption bundle, preferences and indifferences curves Consumption bundle, x represents a vector of goods, ( x 1 , x 2 , x 3 , x 4 , ……, x n ) Assumption of preferences : 1. Completeness: One will be able to tell y x , or y x 2. Transitivity (consistency): If y x and z y , then z x 3. Monotonicity (non-satiation): If i i y x for all i = 1, 2, 3, …, n and there exists at least one j such that j j y x , then y x 4. Continuity: Give a bundle x , if there exist a bundle x y and x z , then there also exists a bundle w between y and z such that w ~ x . We will represent preferences by indifference curves. Note: " " stands for “preferred to” (bundle) and “>” stands for “greater than” (quantity) Properties of indifference curve Indifference curve: shows combinations of goods among which a consumer is indifferent. 1. Indifference curves cannot intersect C B (Monotonicity) A ~ C (On the same indifference curve) A B (Transitivity) B ~ A (On the same indifference curve) Contradiction 2. Indifference curves farther from the origin represent higher utility level As more is preferred to less, A B A ~ C as these two bundles are on the same IC By transitivity, C B 3. Indifference curves are convex Average is preferred to extreme If it is not convex, then extreme is preferred to average. Diminishing MRS 4. Indifference curves are downward sloping More is preferred to less. C A B X 2 X 1 IC 1 IC 2 B C X 2 A X 1 C A B X 2 X 1
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2 Marginal rate of substitution ) , ( y x U U y y U x x U U ( x MU U x U MU x x and y MU U y U MU y y ) 0 y MU x MU U y x y MU x MU y x y x MU MU x y and x y MRS xy y x xy MU MU MRS The Utility maximization Bundle A, B, C, D and E are on the BL, income is exhausted. Bundle F does not use up the whole income. If we are at bundle A, with the given income Utility increases if we move to C and utility is maximized if we move to E. (Increase the consumption of X and reduce Y) At point E, Slope of IC = slope of BL.
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