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ajaz_204_2009_lecture_5 - University of Toronto Department...

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University of Toronto Department of Economics ECO 204 2009 2010 Sayed Ajaz Hussain Lecture 5 1 Ajaz Hussain. Department of Economics. University of Toronto (St. George)
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Today Modeling consumer behavior Budget Constraint Utility Maximization Problem (UMP) UMP with monotonic preferences Imperfect Substitutes Perfect Substitutes Complements Ajaz Hussain. Department of Economics. University of Toronto (St. George) 2
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Modeling Consumers Ajaz Hussain. Department of Economics. University of Toronto (St. George) 3 List all commodities Choose sub set of commodities to model Define consumption set for sub set of commodities Obtain felicity rankings. Represent by appropriate Utility model Solve utility maximization problem (UMP): obtain demands Check if consumer has rational preferences Model budget constraint
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Budget Constraint Expenditure Income Denote income by Y Assume income is exogenous (i.e. parameter) For time being assume income measured in dollars (i.e. pecuniary or nominal units) Later in ECO 204 and RSM 332, income will be measured in real terms Ajaz Hussain. Department of Economics. University of Toronto (St. George) 4
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Prices: Assumptions Assume consumer is price taker Examples? Counter examples? Assume prices are uniform Ajaz Hussain. Department of Economics. University of Toronto (St. George) 5 P Q P Q Uniform Prices Examples? Non uniform Prices Examples?
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Budget Constraints: Some Examples Assume consumer price taker Assume Y is measured in dollars (nominal) terms Single Commodity Budget Constraint P 1 Q 1 Y Two Commodities Budget Constraint P 1 Q 1 + P 2 Q 2 Y Ajaz Hussain. Department of Economics. University of Toronto (St. George) 6
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Two Commodities Budget Constraint Ajaz Hussain. Department of Economics. University of Toronto (St. George) 7 Q 2 Q 1 P 1 Q 1 + P 2 Q 2 Y Edge has equation P 1 Q 1 + P 2 Q 2 = Y Line : P 1 Q 1 + P 2 Q 2 = Y P 2 Q 2 = Y P 1 Q 1 Q 2 = Y/P 2 (P 1 /P 2 )Q 1 Intercept = Y/P 2 Slope = (P 1 /P 2 ) What happens if Y ?
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