IMCH5new07 - Chapter 5 Applications of Rational Choice and...

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Chapter 5 Applications of Rational Choice and Demand Theories Chapter Summary Policy questions can often be illuminated by using micro analysis. This chapter considers a gasoline tax and school vouchers first. Then consumer surplus is used as an instrument to evaluate consumer welfare. Indifference curves and demand curves are used to show consumer surplus. Two-part pricing schemes show how producers try to capture more consumer surplus than they otherwise would have. The effect of housing price changes and the biases of the CPI are discussed, after which market demand elasticity cases are analyzed. The remainder of the chapter deals with intertemporal choice topics so that the consumer's choice problem can be seen as a choice among goods which become conditioned by time. The interaction of the consumer's time preference with the intertemporal choices she faces is observed in numerous settings including alternative interest rate and lifetime income scenarios. Chapter Outline Chapter Preview Using the Rational Choice Model to Answer Policy Questions Consumer Surplus Two-Part Pricing Overall Welfare Comparisons Using Price Elasticity of Demand The Intertemporal Choice Model Summary Appendix: Additional Applications of Rational Choice and Demand Theories Teaching Suggestions 1. In a sense this chapter is its own instructor's manual because it is really an application chapter of the theory learned in earlier chapters. School vouchers and a gasoline tax are among the most interesting examples of this theory, but the time value of money may be the most important concept that needs constant reinforcing. 2. The notion that time enters into a determination of value is one of the most important concepts a student must master. Discount rates and interest rates are important because we prefer things now rather than in the future. One way to start the discussion is to ask students which clothes they wear first after they have finished their wash and have all their clothes to choose from. Do they pick the favored shirt first or get the less favored "out of the way" by wearing it first? When they see this behavior as part of the response to a person's discount rate, ask students to predict the discount rates of various faculty in the department or of each other. Before long they get the idea that time preference is as much a matter of individual choice as any commodity choice. Given the differences in time preference, it should be clear that a market will evolve to provide opportunities to exchange things across time. Examples other than clothing are equally useful. Which food do you eat first if you must eat both your favorite and something healthy? Do you do your homework first and then party or the other way around? Is religion a matter of time preference? It is hard to overdo the importance of time preference, so some time should be spent on the reasons for differences in time preference that are presented in the text.
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IMCH5new07 - Chapter 5 Applications of Rational Choice and...

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