05s - 2011/3/8 Economic Rationality The principal...

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2011/3/8 1 5 Choice 2 Economic Rationality The principal behavioral postulate is that a decisionmaker chooses its most preferred alternative from those available to it. The available choices constitute the choice set. How is the most preferred bundle in the choice set located? 3 Rational Constrained Choice Affordable bundles x 1 x 2 More preferred bundles 4 Rational Constrained Choice x 1 x 2 x 1 * x 2 * (x 1 *,x 2 *) is the most preferred affordable bundle.
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2011/3/8 2 5 Rational Constrained Choice The most preferred affordable bundle is called the consumer’s ORDINARY DEMAND at the given prices and budget. Ordinary demands will be denoted by x 1 *(p 1 ,p 2 ,m) and x 2 *(p 1 ,p 2 ,m). 6 Rational Constrained Choice When x 1 * > 0 and x 2 * > 0 the demanded bundle is INTERIOR. If buying (x 1 *,x 2 *) costs $m then the budget is exhausted. 7 Rational Constrained Choice x 1 x 2 x 1 * x 2 * (x 1 *,x 2 *) is interior. (a) (x 1 *,x 2 *) exhausts the budget; p 1 x 1 * + p 2 x 2 * = m. 8 Rational Constrained Choice x 1 x 2 x 1 * x 2 * (x 1 *,x 2 *) is interior . (b) The slope of the indiff. curve at (x 1 *,x 2 *) equals the slope of the budget constraint.
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2011/3/8 3 9 Rational Constrained Choice (x 1 *,x 2 *) satisfies two conditions: (a) the budget is exhausted; p 1 x 1 * + p 2 x 2 * = m (b) the slope of the budget constraint, - p 1 /p 2 , and the slope of the indifference curve containing (x 1 *,x 2 *) are equal at (x 1 *,x 2 *).
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05s - 2011/3/8 Economic Rationality The principal...

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