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5- income substit effects_1

5- income substit effects_1 - Click to edit Master title...

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Click to edit Master title style 8/16/11 Thomas Nechyba A set of points is non-convex if it is not convex; i.e. we can find at least two points ( in the set ) such that a portion of the line that connects these points lies outside the set . Non-Convex Choice Set A non-convex choice set (with kinks) can lead to multiple “best” bundles. The same can also happen if the non-convex choice set is without kinks . A non-convex upper contour set violates our “averages are better than extremes” assumption … … and can also lead to multiple “best” bundles”. Non-Convex Upper Contour Set Non-convexities in budgets or tastes can therefore lead to multiple “optima”. Non-Convexities and Multiple “Optima”

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Click to edit Master title style 8/16/11 Thomas Nechyba While we will often assume linear budget lines , the uniqueness of the “best bundle” only depends on the convexity of the choice set. An outwardly kinked budget constraint, for instance, gives rise to a convex choice set . This may result in … … optimum A on the flatter portion … … optimum A on the kink … … or optimum A on the steeper portion. But it always results in a single “best” bundle because of the underlying convexity. Assuming Convexity Guarantees Uniqueness
Click to edit Master subtitle style 8/16/11 Thomas Nechyba Homothetic Tastes, Marginal Rates of Substitution, and Indifference Curves 1. Change in Income (or Wealth) cause shifts in budgets 2. Change in Prices – cause rotations in budgets Changing Economic Circumstances Change in Economic Circumstance s We now ask how “Choice” – or Behavior – changes as economic circumstances change Consumers may experience these changes in economic circumstances because of market forces (i.e. changes in demand and supply) or because of government policies (like taxes, subsidies and regulations.)

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Click to edit Master subtitle style 8/16/11 Thomas Nechyba Homothetic Tastes, Marginal Rates of Substitution, and Indifference Curves Changes in Income – Quasilinear Goods Suppose we begin with the blue budget and then experience an increase in income that takes us to the magenta budget . Our optimal consumption bundle on the blue budget is A … and our optimal bundle on the magenta budget is B . In this case, our consumption of pasta is unaffected by the increase in income – all the additional income goes into steak consumption. This is because the MRS is unchanged along the vertical dashed line – i.e. tastes are quasilinear in pasta . Pasta is then referred to as a quasilinear good i.e. a good whose consumption for a consumer
8/16/11 Thomas Nechyba Homothetic Tastes, Marginal Rates of Substitution, and Indifference Curves Changes in Income – Normal Goods But for different tastes, the change in behavior from the same change in income might be different.

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