Lecture02 - Lecture 2: Consumer Choice Perlo Chapter 3...

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Lecture 2: Consumer Choice Perlo/ Chapter 3 Vladimir Petkov VUW 05 March 2009 Vladimir Petkov (VUW) Lecture 2: Consumer Choice 05 March 2009 1 ± 26
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Example of Constrained Maximization Imagine a hill with height shown by contours. You want to climb as high as possible. 450 N 450 100 200 300 400 450 Vladimir Petkov (VUW) Lecture 2: Consumer Choice 05 March 2009 2 / 26
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Example of Constrained Maximization (Continued) A path runs up the hill from point A to the summit. But a fence BC runs across the hill barring access to the public. This means that you cannot climb higher up the hill than point Z on the 300 contour line: 450 N 450 100 200 300 400 450 A B C Z Vladimir Petkov (VUW) Lecture 2: Consumer Choice 05 March 2009 3 / 26
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Example of Constrained Maximization (Continued) Now instead of a physical hill that you climb, imagine a mountain of This is the basic idea of how we model consumer behavior. Good 2 Good 1 100 200 300 350 Vladimir Petkov (VUW) Lecture 2: Consumer Choice 05 March 2009 4 / 26
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Consumer Preferences We start the analysis by examining consumer preferences. Consumers choose how to allocate their money to buy a bundle of goods. To explain how these choices are made, economists assume that consumers have a set of tastes . These tastes may di/er among individuals. Consumer preferences are essentially a ranking of the di/erent bundles of goods. This ranking is assumed to satisfy certain properties. Some of these properties must always hold, some can be violated. Vladimir Petkov (VUW) Lecture 2: Consumer Choice 05 March 2009 5 ± 26
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Graphical Representation of Preferences To represent preferences graphically, we use indi/erence curves and indi/erence maps. An indi/erence curve is the set of all bundles that make a consumer indi/erent. If we plot all indi/erence curves we get an indi/erence map . x 2 x 1 Increasing utility Vladimir Petkov (VUW) Lecture 2: Consumer Choice 05 March 2009 6 ± 26
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Properties of Consumer Preferences Mandatory Properties To be able to make consistent predictions about consumer behavior, all preferences must satisfy the two requirements below. Completeness . When facing a choice between any two bundles of goods, a consumer can rank them so that one and only one of the following relationships is true: the consumer prefers the &rst bundle to the second; or the consumer prefers the second bundle to the &rst; or the consumer is indi/erent between the two bundles. Transitivity
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Lecture02 - Lecture 2: Consumer Choice Perlo Chapter 3...

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