Week3 Handout (6pp) - Choice Ch 5: Choice Ch 6: Demand...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Choice Ch 5: Choice Ch 6: Demand (sec. 2,5,6,8 & appendix) Ch 15: Market Demand (sec. 1& 2) 2 Rational Choice The principal behavioral postulate is that a decisionmaker chooses its most preferred alternative from those available to it. In terms of our model, this means choosing a bundle from the highest indifference curve that can be reached without exceeding the budget set. 3 Rational Constrained Choice x 1 x 2 Affordable bundles 4 Rational Constrained Choice Affordable bundles x 1 x 2 More preferred bundles 5 Rational Constrained Choice x 1 x 2 x 1 * x 2 * (x 1 *,x 2 *) is the most preferred affordable bundle. 6 Rational Constrained Choice The most preferred affordable bundle is called the consumers ORDINARY DEMAND at the given prices and budget. Ordinary demands will be denoted by x 1 *(p 1 ,p 2 ,m) and x 2 *(p 1 ,p 2 ,m). 7 Choice with monotonic preferences Supposed preferences are monotonic, i.e. more is better; Then the consumer will always choose a bundle that exhausts the budget. The chosen bundle is interior if it contains strictly positive quantities of both goods. 8 Rational Constrained Choice When preferences are monotonic, indifference curves are smoothly convex and the chosen bundle is interior, (x 1 *,x 2 *) satisfies two conditions: (a) the budget is exhausted; p 1 x 1 * + p 2 x 2 * = m (b) the slope of the budget constraint, - p 1 /p 2 , and the slope of the indifference curve containing (x 1 *,x 2 *) are equal at (x 1 *,x 2 *). 9 Choice: The canonical case x 1 x 2 x 1 * x 2 * (x 1 *,x 2 *) is interior . (a) (x 1 *,x 2 *) exhausts the budget; p 1 x 1 * + p 2 x 2 * = m. (b) The slope of the indiff. curve at (x 1 *,x 2 *) equals the slope of the budget constraint. 10 Solving for the optimum bundle If the budget is exhausted, then the optimum bundle must satisfy the budget constraint with equality: p 1 x 1 * + p 2 x 2 * = m If the optimum bundle is interior, then it must be a point at which the slope of the budget line equals the slope of the indifference curve, i.e.: - p 1 /p 2 = MRS We can use these two equations to solve for the two variables x 1 *and x 2 * . 11 Computing Ordinary Demands - a Cobb-Douglas Example. Suppose that the consumer has Cobb-Douglas preferences. Then U x x x x a b ( , ) 1 2 1 2 MU U x ax x a b 1 1 1 1 2 MU U x bx x a b 2 2 1 2 1 12 Computing Ordinary Demands - a Cobb-Douglas Example. So the MRS is At (x 1 *,x 2 *), MRS = -p 1 /p 2 so MRS dx dx U x U x ax x bx x ax bx a b a b 2 1 1 2 1 1 2 1 2 1 2 1 / / . ax bx p p x bp ap x 2 1 1 2 2 1 2 1 * * * * ....
View Full Document

This note was uploaded on 02/29/2012 for the course ECON 2101 taught by Professor Unknown during the One '11 term at University of New South Wales.

Page1 / 16

Week3 Handout (6pp) - Choice Ch 5: Choice Ch 6: Demand...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online