Solution example figure 6 6 a corner solution example

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Unformatted text preview: erence curves move out from the origin they represent higher and higher utility. !"#$%&'())*+,-',).+/-0)1+&20/+-)3/04 .',5'60)12780/020'8 9 :; <-=/55','-6')62,>'8 ?2=@'0)&/-' B%0/$#& *4+/6' A :; C Figure A Corner solution example. Figure 6: 6: A corner Solution Example. 4 !" Consumer Choice with Composite Goods 7 In reality, consumers choose from many different goods. One method that economists use to analyze the consumer’s choice of a particular good in a tractable way is to group all other goods together in a category called a composite good. A composite good simply represents the collective expenditures on every other good except the commodity being considered. The price of the composite good is usually set (or normalized) to 1. The composite good is usually graphed on the vertical axis. The textbook examines four applications of the theory of consumer choice using composite goods. The applications deal with situations and programs commonly observed in the real world. The treatment of these applications is pretty clear in the textbook so I won’t try to improve on it in these notes. Read through the examples carefully since they give you a good flavour of how the theory we’ve developed so far can be applied to understand the effects on choice and incentives of these common schemes. If you have any questions feel free to send me an email. One thing to note, in the application to housing vouchers in particular, is the theory we’ve developed is of no use in telling us whether, for example, the coupons are a better policy than the cash subsidies. Some consumers actually prefer (i.e. are happier) with the cash subsidies than with a housing coupon of equivalent value. Given that hb is the government’s preferred level of housing for the consumers, the coupon system can be cheaper to implement. How the government decided hb is best for the consumer is beyond the scope of our theory so far (and any theory we’ll develop in this course). 5 Revealed Preference Even if we don’t know the consumer’s preferences, we can infer properties of the consumer’s preferences by observing her choices as prices and income vary. Essentially, if we observe that a consumer chooses a basket of goods A when she can also afford the basket of goods B, we can conclude that she weakly prefers basket A to basket B: A % B. If a consumer chooses basket C which is strictly more expensive than basket D we can conclude that she strictly prefers basket C: C D. As income and prices change we can observe how choices change and infer the consumer’s preferences. Throughout, we assume that preferences stay constant as income and prices change and that preferences are monotone. Consider a consumer choosing between two goods. Monotonicity implies that any basket to the north-east of a chosen basket in the space of the two goods is strictly preferred to that basket. It is not uncommon to observe consumer choice that is inconsistent with the assumption that the consumer is maximizing utility subject to a budget constraint. Take a look at the Learning-by-doing exercises 4.5 and 4.6 for examples. 6...
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