Lecture3 - Fin501 FinancialEconomics...

Info iconThis preview shows pages 1–13. Sign up to view the full content.

View Full Document Right Arrow Icon
Fin 501 Financial Economics Lecture 3: Utility Maximization, Demand and Elasticities Professor Nolan Miller 1
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Announcements The math review notes are posted on Compass. Problem Set #1 is due on Tuesday, Sept. 7, 2010  ***NOTE CHANGE  IN DUE DATE***. 2
Background image of page 2
Last Time … Demand (Graphically) Preferences Rationality Utility Functions Marginal Rate of Substitution 3
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
This time … Examples of Utility Functions. Budget Constraints. Utility Maximization Problem. Solving UMP: Demand Functions. Impact of changes in wealth. Impact of changes in prices. Elasticities. Market Demand 4
Background image of page 4
5 Examples of Utility Functions Relative sizes of  α  and  β  indicate the  relative importance of the goods. MRS is constant along rays from the  origin. “Homothetic” MRS decreases smoothly. Q of x Q of y
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
6 Examples of Utility Functions Perfect Substitutes utility =  U ( x , y ) =  α x  +  β y Indifference curves are linear. One unit of x is always  equivalent to  α / β   units of y. 2-liter bottles and 1-liter bottles. MRS is constant along the  indifference curves. Q of x Q of y
Background image of page 6
7 Examples of Utility Functions Perfect Complements utility =  U ( x , y ) = min ( α x β y ) Think of left shoes and right  shoes. Goods are valued in fixed  proportions. There is no substitution  between goods. Q of x Q of y
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
8 Constraints on choices Utility functions describe consumers’ preferences. Consumers prefer more to less. Why don’t they choose to have more of everything? They face a budget constraint.
Background image of page 8
9 Budget Constraints Let p x  be the price of x and p y  be the price of y. Suppose the consumer has m units of wealth. Then the consumer’s choice must satisfy the Budget Constraint: p x  x + p y  y ≤ m. And, since goods are real, we also require x and y to be non-negative (≥0). If consumers maximize, there is no satiation and no savings, then the  budget constraint should hold with equality.
Background image of page 9

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
10 The Budget Constraint Rearrange the budget  equation to get: y = -p x /p y  * x + m/p y . Slope is –p x /p y . Spend m on x, buy m/p x   units. Sepend m on y, buy m/p y   units. Set of feasible choices in  green. m/p y m/p x Slope = - p x /p y (price ratio) p x x + p y y = m x y
Background image of page 10
11 What happens when m increases from  m 1  to m 2? m 1 /p y m 1 /p x p x x + p y y = m 1 x y p x x + p y y = m 2 Note that m is only valuable because larger m’s mean bigger budget sets.   Wealth is not valued/consumed directly.
Background image of page 11

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
What happens when p x  increases from  p x1  to p x2 ? m/p
Background image of page 12
Image of page 13
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 06/05/2011 for the course FIN 580 taught by Professor Staff during the Spring '08 term at University of Illinois, Urbana Champaign.

Page1 / 67

Lecture3 - Fin501 FinancialEconomics...

This preview shows document pages 1 - 13. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online