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# IMCH3new07 - Chapter 3 Rational Consumer Choice Chapter...

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Chapter 3 Rational Consumer Choice Chapter Summary This chapter presents the basic model of rational consumer choice using indifference curves and budget lines. The text explains briefly that rational consumer choice theory assumes that consumers already have well-defined preferences. From here, the chapter proceeds with an explanation of budget constraints (also referred to as opportunity sets) using food and shelter as the two goods. The section on budget constraints continues with an explanation of shifts in the budget line due to income and price changes; it concludes with a section on Marshallian money. The section on consumer preferences begins with an explanation of preference orderings and a presentation of the four assumptions necessary for indifference curves: completeness, transitivity, more is better, and diminishing marginal rate of substitution (an explanation of MRS is provided). These assumptions lead to indifference curves that are negatively sloped and convex. The text continues by linking budget line and indifference analysis to find the best feasible bundle of goods. This will occur where the MRS = the price ratio of the goods in question. The composite good concept for the Y axis is also explained. Next, applications using food stamp policy and gift giving behavior are considered. In the appendix the utility function approach to utility maximization is explained and illustrated. Calculus is used to solve the utility maximization process. Chapter Outline Chapter Preview The Opportunity Set or Budget Constraint Consumer Preferences The Best Feasible Bundle Applications of the Rational Choice Model Appendix: The Utility Function Approach to Utility Maximization Appendix: The Mathematical Approach to Utility Maximization Summary Teaching Suggestions 1. Since students are already familiar with a production possibility curve from principles class, it is helpful to use that concept to derive a consumption possibility curve. Reason with them about what the intercepts would be for a given amount of income. If you have \$100 income and the price of shelter is \$10, how many units of shelter can you buy? If food costs \$5 per unit, what amount of food will exhaust your budget? Although this sounds simple, it will make the intercepts of the budget line logically equal M/P s and M/P f . Once they have the intercepts mastered, sketch in the budget line. Now by taking rise over run, the slope of the budget line will equal P s /P f . Next, go from the definition of the budget constraint, M = P s S + P f F, and solve for Y. The outcome, Y = M/P f - P s /P f X, will suddenly make sense and be easier to work with. Before indifference curves clutter up the graph, take the time to play with the budget line. Raise and lower the nominal price of shelter. Alter income and the price of Y. Make sure that real and nominal income changes are understood because it will pay off when relating the model to the derivation of normal demand, which assumes nominal income

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