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325_Lecture2_Jan26

# 325_Lecture2_Jan26 - REVIEW OF CONSUMER THEORY(CONTINUED...

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1 R EVIEW OF C ONSUMER T HEORY (C ONTINUED ) J ANUARY 26, 2011 January 26, 2011 2 U TILITY F UNCTIONS Review of Consumer Theory Marginal Rate of Substitution (MRS) Maximum quantity of one good consumer is willing to give up to obtain one extra unit of the other good Graphically, the (negative of the) slope of an indifference curve MRS is itself a function of c 1 and c 2 (i.e., MRS ( c 1 , c 2 )) MRS equals ratio of marginal utilities Using Implicit Function Theorem (see Practice Problem Set 1) Summary: whether graphically- or mathematically-formulated, utility functions describe the benefit side of consumer optimization c 1 c 2 1 1 2 1 2 2 1 2 ( , ) ( , ) ( , ) u c c MRS c c u c c

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2 January 26, 2011 3 B UDGET C ONSTRAINTS The Graphics of Consumer Theory Describe the cost side of consumption One-good case (trivial): Pc = Y Assume income Y is taken as given by consumer for now… Two-good case (interesting): P 1 c 1 + P 2 c 2 = Y Assume income Y is taken as given by consumer for now… January 26, 2011 4 B UDGET C ONSTRAINTS The Graphics of Consumer Theory Describe the cost side of consumption One-good case (trivial): Pc = Y Assume income Y is taken as given by consumer for now… Two-good case (interesting): P 1 c 1 + P 2 c 2 = Y Assume income Y is taken as given by consumer for now… Plotted in 3D-consumption-space Plotted in 2D-consumption-space Slope = - P 1 / P 2
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325_Lecture2_Jan26 - REVIEW OF CONSUMER THEORY(CONTINUED...

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