# ECON325 problem set 1 answer - REVIEW OF CONSUMER THEORY...

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1 R EVIEW OF C ONSUMER T HEORY (C ONTINUED ) J ANUARY 26, 2011 January 26, 2011 2 U TILITY F UNCTIONS Review of Consumer Theory ± Marginal Rate of Substitution (MRS) ± Maximum quantity of one good consumer is willing to give up to obtain one extra unit of the other good ± Graphically, the (negative of the) slope of an indifference curve ± MRS is itself a function of c 1 and c 2 (i.e., MRS ( c 1 , c 2 )) ± MRS equals ratio of marginal utilities ± ± Using Implicit Function Theorem (see Practice Problem Set 1) ± Summary: whether graphically- or mathematically-formulated, utility functions describe the benefit side of consumer optimization c 1 c 2 112 12 212 (, ) ucc MRS c c =

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2 January 26, 2011 3 B UDGET C ONSTRAINTS The Graphics of Consumer Theory ± Describe the cost side of consumption ± One-good case (trivial): Pc = Y ± Assume income Y is taken as given by consumer for now… ± Two-good case (interesting): P 1 c 1 + P 2 c 2 = Y ± Assume income Y is taken as given by consumer for now… January 26, 2011 4 B UDGET C ONSTRAINTS ± Describe the cost side of consumption ± One-good case (trivial): Pc = Y ± Assume income Y is taken as given by consumer for now… ± Two-good case (interesting): P 1 c 1 + P 2 c 2 = Y ± Assume income Y is taken as given by consumer for now… Plotted in 3D-consumption-space
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## This note was uploaded on 06/09/2011 for the course ECON 325 taught by Professor Chugh during the Spring '08 term at Maryland.

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ECON325 problem set 1 answer - REVIEW OF CONSUMER THEORY...

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