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 mathematicallyformulated,
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
This preview has intentionally blurred sections. Sign up to view the full version.
View Full Document
2
January 26, 2011
3
B
UDGET
C
ONSTRAINTS
The Graphics of Consumer Theory
Describe the
cost
side of consumption
Onegood case (trivial):
Pc = Y
Assume income
Y
is taken as given by consumer for now…
Twogood 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
Onegood case (trivial):
Pc = Y
Assume income
Y
is taken as given by consumer for now…
Twogood case (interesting):
P
1
c
1
+
P
2
c
2
=
Y
Assume income
Y
is taken as given by consumer for now…
Plotted in 3Dconsumptionspace
Plotted in 2Dconsumptionspace
Slope = 
P
1
/
P
2
This is the end of the preview.
Sign up
to
access the rest of the document.
 Spring '08
 chugh
 Optimization, Utility, Mathematical optimization, lagrange multipliers

Click to edit the document details