Ch 8 Possibilities Preferences and Choices

# Ch 8 Possibilities Preferences and Choices - Possibilities,...

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Possibilities, Preferences and Choices Chapter 8 1

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Recall that consumer equilibrium is obtained when the following condition is satisfied: Consumers maximize subject to budget constraint: Income ≥ P X *Q X +P Y *Q Y Budget line: Q y = -P x /P y * Q x + I/P y We can now compare the budget line with the consumers indifference curves to find optimal bundle Indifference Curve : a line that shows combinations of Consumer Equilibrium 2 y y X X P MU P MU =
Indifference Curves By definition bundle A, B, and D all provide the same utility. More is always better Thus point C is preferred to A, B, and D 3 IC 1 IC 2 4 5 6 A B D C 2 3 6 Q HC Q D -3

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All the points above the indifference curve are preferred to the points on the curve. And all the points on the indifference curve are preferred to the points below the curve. Indifference Curves 4
Indifference Curves Negative slope Slope gets flatter as “x” increases Slope (∆y/ ∆x) measures how much “y” changes as good “x” changes Marginal Rate of Substitution (MRS) = measures the rate at which a person is willing to give up good y to get an additional unit of good x while at the same time remaining indifferent (remain on the same indifference curve). 5

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Indifference Curves MRS is the negative of the slope Slope is always < 0, thus MRS > 0 The magnitude of the slope of the indifference curve measures the marginal rate of substitution. Better indifference curves are always up and to the right (northeast) 6
Best Affordable Choice The consumer’s best affordable choice is < On the budget line < On the highest attainable indifference curve

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## This note was uploaded on 02/23/2012 for the course ECONOMICS 251 taught by Professor Kelly during the Summer '11 term at Purdue University.

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Ch 8 Possibilities Preferences and Choices - Possibilities,...

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