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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
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*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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- Summer '13