Chapter 2

Chapter 2 - Part I Utility Maximizing Choice Con sumers...

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Unformatted text preview: Part I: Utility Maximizing Choice: Con- sumers, Workers and Savers We will begin our formal treatment of microeconomics with an analysis of individual choice in settings where individuals are trying to maximize their happiness . This will involve thinking about two conceptually different parts that feed into the choices we make: First, individuals face different economic circumstances or constraints — and they therefore have to choose from options that are limited by their own character- istics (such as their income, their inherent talents, etc.) and by conditions in the external world (such as prices and wages). Second, individuals have different tastes of preferences and are thus willing to make different tradeoffs between different types of goods, between working more or less, consuming now or saving for the future. Our “best” course of action results from looking at what is possible (i.e. our cir- cumstances) and then picking what makes us happiest from the set of possibilities we face. Put in mathematical language, individual choice thus implies optimizing subject to the constraints we face . This basic method of choosing applies to many different settings. Consumers choose the best combination of goods and services given their scarce resources and given the prices they face in stores. Workers choose where to work and how much to work given their level of skill and expertise and given the wages that are paid by employers, and by making this choice they are implicitly choosing how much they will have available for consumption of goods and services. Savers make choices about how much to consume now and how much to put away for the future given their current and expected future resources and given the rates of return their investments can produce. Alternatively, they might choose how much to borrow on the future now (and thus how much future consumption to give up in order to consume now). The choices we make as consumers, workers and savers are different, but the underlying method of choosing the best option given what is possible is conceptually the same. For this reason, we will develop our model of consumer, worker and saver choices simultaneously, and for this reason this part of the text is a bit longer than in other microeconomics texts where only the consumer model is developed. In Chapters 2 and 3, we begin with the first part of choice by modeling the economic circumstances or constraints that consumers (in Chapter 2), workers and savers (in Chapter 3) face when making choices. We will see the beginning of what we alluded to in Chapter 1: the role that incentives play in structuring the options from which individuals can choose. At the most basic level, these incentives are captured by the prices that individuals face — prices of goods and services in stores, wages 27 28 in the workplace and interest rates (or rates of return) in financial markets. These prices create the fundamental tradeoffs we face — determining what we will call the...
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Chapter 2 - Part I Utility Maximizing Choice Con sumers...

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