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ECON10A_9 (1)

# ECON10A_9 (1) - Review 1 Substitutes E x1 p2 > 0 E x2 p1 >...

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1/4/2008 1 Review

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1/4/2008 2 Substitutes p 1 X 1 X 2 I/p 1 I/p 2 In other words, p 1 ↑→x 2 p 2 ↑→x 1 Tend not to combine these goods Note: Do not confuse with “perfect” substitutes 0 , 0 1 2 2 1 , , p x p x E E p 1 ↑→x 2
1/4/2008 3 Complements p 1 X 1 X 2 I/p 1 I/p 2 In other words, p 1 ↑→x 2 p 2 ↑→x 1 Tend to use these goods together Note: Do not confuse with “perfect” complements 0 , 0 1 2 2 1 , , < < p x p x E E p 1 ↑→x 2

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1/4/2008 4 Compensated price change – Analysis  Say p 1 (Beer) Must end up on new (red budget line). : But imagine H.H., esq., is compensated enough to make him as happy as before Mom finds the cheapest way to do this. New optimum (X 1 ’*, X 2 ’*) We call this H.H.’s response to a compensated price change Note: If HH had returned to original choices, it would have been more costly to get same level of utility (blue line). X 1 X 2 HH says: “I’m consuming less beer and more pizza, dear Mumsy, but I am just as happy.” X 1 * X 1 ’* X 2 * X 2 ’*
1/4/2008 5 Decomposing price changes p 1 Pick initial optimum A Draw new budget line Draw parallel budget line Pick point B Draw indif curve through A and B (This gives sub effect) Figure out where to put C X 1 X 2 B A C 1 C 2 C 3 C 4

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1/4/2008 6 Question 1 p 1 Good 2 inferior Where is the optimum consumption bundle after the price change? 1. C 1 2. C 2 3. C 3 4. C 4 X 1 X 2 B A C 1 C 2 C 3 C 4
7 Question 2 p 1 Goods 1 and 2 subs Good 2 normal Where is the optimum consumption bundle after the price change? 1. C

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ECON10A_9 (1) - Review 1 Substitutes E x1 p2 > 0 E x2 p1 >...

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