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Unformatted text preview: Chapter 6 Doing the Best We Can 1 We began our introduction of microeconomics with the simple premise that economic agents try to do the best they can given their circumstances. For three types of economic agents consumers, workers and individuals planning for the future we showed in Chapters 2 and 3 how choice sets can be used to illustrate the circumstances these economic agents face when making choices. We then illustrated in Chapters 4 and 5 how we can model individual tastes giving us a way of now addressing how individuals will judge which of their available choices is indeed the best. Chapters 2 through 5 therefore developed our basic model of individual choice sets and tastes, the first step in our economic analysis of choice. We now begin the second step the analysis of how individuals in our basic model optimize i.e. how they would behave if they are indeed doing the best they can. 6A Graphical Optimization Approaches We begin by building some intuition about how tastes and choice sets interact to determine optimal choices. This means that we will essentially combine the graphs of Chapters 2 and 3 with those of Chapters 4 and 5 as we return to some of the examples we raised in those chapters. In the process, well begin to get our first glimpse at the important role played by market prices in helping us exploit all the potential gains from trade that would be difficult to realize in the absence of such prices. Then, in Section 6A.2, we consider scenarios under which individuals may choose to not purchase any quantity of a particular good scenarios we will refer to as corner solutions . And, in Section 6A.3, we will uncover scenarios under which individuals may discover that more than one choice is optimal for them, scenarios that arise when either choice sets or tastes exhibit non-convexities . 6A.1 The Best Bundle of Shirts and Pants Suppose we return to my story of me going to Wal-Mart with $200 to spend on shirts and pants, with shirts costing $10 each and pants costing $20 per pair. We know from our work in Chapter 2 that, in a graph with pants on the horizontal axis and shirts on the vertical, my budget constraint 1 Chapters 2,4 and 5 are required as reading for this chapter. Chapter 3 is not necessary. 128 Chapter 6. Doing the Best We Can 3 intersects at 20 on the vertical and at 10 on the horizontal. Its slope which gives expression to the opportunity cost of one more pair of pants in terms of how many shirts I have to give up is 2. Suppose further that the marginal rate of substitution is equal to 2 at all bundles where I have twice as many shirts as pants, that it is equal to 1 at bundles where I have an equal number of shirts and pants, and that it is equal to 1 / 2 at bundles where I have twice as many pants as shirts. (This is an example of what we called homothetic tastes in Chapter 5.) My budget constraint and choice set are then graphed in Graph 6.1a, and some of the indifference curves fromconstraint and choice set are then graphed in Graph 6....
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- Fall '07