321_5 - ECON 321 Spring 2011: Lecture 5 Chapter 7: Revealed...

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ECON 321 Spring 2011: Lecture 5 Chapter 7: Revealed Preference
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Review from last time: Optimal Choice Consumer chooses highest utility bundle on budget constraint. 3 types of utility functions to deal with Linear / Perfect Substitutes: Always a corner solution Leontief (min) / Perfect Complements: Always consumed in fixed ratio Convex Preferences with Interior optima: Set MRS = price ratio
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Step 1 Is the utility function linear? i.e. is it of the form: No: move to step 2 Yes: Perfect Substitutes. Try both corners and choose the one with the highest utility: i.e. check: The optimal choice is the one with the higher utility. 2 1 2 1 ) , ( bx ax x x u + = 2 1 , 0 0 , p m u and p m u
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Step 2 It wasn’t linear, is it a minimum function? i.e. is it of the form: No: go to step 3 Yes: set the expressions on either side of the comma equal to each other. i.e. the
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321_5 - ECON 321 Spring 2011: Lecture 5 Chapter 7: Revealed...

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