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lecture3

# lecture3 - Professor Jay Bhattacharya Spring 2001 The...

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Professor Jay Bhattacharya Spring 2001 Econ 11--Lecture 3 1 Spring 2001 Econ 11--Lecture 3 1 Correction from Last Week • The algebraic representation of the budget constraint for food stamps is: food house food food food house p food I house p p p food p food p I house 10 if 10 10 if = + < = Spring 2001 Econ 11--Lecture 3 2 The Theory of the Consumer Model of individual choice: – “Consumers choose the best bundle of goods and services that they can afford .” • 1) “afford” depends upon opportunities / budget constraints • 2) “best” depends upon preferences • 3) “choice” assumes rational, optimizing behavior Spring 2001 Econ 11--Lecture 3 3 Consumer Preferences We want to summarize how the consumer evaluates alternative bundles of goods, i.e. we want a “binary ordering” from which we can tell which bundle of goods is preferred. – Example: 2 Goods (Houses, BMWs) – Choices: (0, 2) (1, 1.5) (2, 1) (3, .5) (4, 0) – Rank: 5th 2nd 1st 3rd 4th Goal: We want a simple model of consumer preferences Spring 2001 Econ 11--Lecture 3 4 Preference Orderings Example Houses BMWs 1 2 3 4 1 2 1 st 2 nd 3 rd 4 th 5 th Spring 2001 Econ 11--Lecture 3 5 Axioms of Consumer Preference We want our ordering to have the following six features: 1 Completeness : Any 2 bundles can be compared 2 Transitivity: If x > y and y > z, then x > z 3 Continuity : If 2 bundles are very similar, they should be “close” in the preference ordering Spring 2001 Econ 11--Lecture 3 6 Axioms of Consumer Preference 4 Non-satiation : “More is better,” or“goods are good” 5 Convexity : “Averages are better” 6 Differentiability : No sharp breaks in the rate of change of preferences Axioms 1-6 imply ‘Well-Behaved’ Preferences.

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Professor Jay Bhattacharya Spring 2001 Econ 11--Lecture 3 2 Spring 2001 Econ 11--Lecture 3 7 Indifference Curves We can describe these preferences graphically via an indifference curve which connects all bundles which are equally preferred. – “Connect the dots” BMWs Houses Spring 2001 Econ 11--Lecture 3 8 Indifference Curves Slope Downward We can show that indifference curves slope downward. This follows from the axiom of non-satiation more X 2 less X 1 more X 2 more X 1 less X 2 less X 1 less X 2 more X 1 X 2 X 1 X 2 * X 1 * Spring 2001 Econ 11--Lecture 3 9 Convexity of Indifference Curves Averages are Better than Extremes e.g., Most people would prefer 1 bag of tortilla chips and 1 jar of salsa over 2 jars of salsa e.g., Most people would prefer some income and some
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