2010_lecture_6_ho

2010_lecture_6_ho - Economics 101Lecture 6 Substitution and...

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Economics 101—Lecture 6 Substitution and Income Effects George J. Mailath February 1, 2011
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In our last episode 1 We studied utility maximization subject to a budget constraint, using MRS ij = U i U j = p i p j for cases like Cobb-Douglas, as well as showing that the condition does not always work (e.g., perfect substitutes and perfect complements). 2 The value of Lagrange multiplier λ * = λ ( p , I ) is the marginal utility of income. 3 Showed that consumers prefer a lump sum tax to a sales tax.
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How does demand respond to a price change? A price increase has both a substitution effect (the relative price has changed) and an income effect (fewer bundles affordable).
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The substitution effect Moving along an indifference curve (and so keeping utility or “real” income fixed as relative prices change).
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The expenditure function Given prices p , and a utility level u , how much income is needed to achieve u ? That is, what is the lowest I satisfying V ( p , I ) = u . Equivalently, we solve the
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This note was uploaded on 03/02/2011 for the course ECON 101 taught by Professor Dannicatambay during the Spring '08 term at UPenn.

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2010_lecture_6_ho - Economics 101Lecture 6 Substitution and...

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