Some simplifying assumptions Consumers objective to maximize hisher utility

Some simplifying assumptions consumers objective to

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Some simplifying assumptions Consumer’s objective: to maximize his/her utility subject to income constraint 2 goods (X, Y) Prices Px, Py are fixed Consumer’s income (I) is given
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Consumer Equilibrium Marginal utility per price additional utility derived from spending the next price on the good MU per last dollar = MU P
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Consumer Equilibrium Optimizing condition: If spend more on good X and less of Y X Y X Y MU MU P P X Y X Y MU MU P P
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Numerical Illustration Q x TU X MU X MUx Px Q Y TU Y MU Y MUy Py 1 30 30 15 1 50 50 5 2 39 9 4.5 2 105 55 5.5 3 45 6 3 3 148 43 4.3 4 50 5 2.5 4 178 30 3 5 54 4 2 5 198 20 2 6 56 2 1 6 213 15 1.5
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Simple Illustration Suppose: X = fishball Y = fishcake Assume: P X = 2 P Y = 10
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Cont. 2 potential optimum positions Combination A: X = 3 and Y = 4 TU = TU X + TU Y = 45 + 178 = 223 Combination B: X = 5 and Y = 5 TU = TU X + TU Y = 54 + 198 = 252
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Cont. Presence of 2 potential equilibrium positions suggests that we need to consider income. To do so let us examine how much each consumer spends for each combination. Expenditure per combination Total expenditure = P X X + P Y Y Combination A: 3(2) + 4(10) = 46 Combination B: 5(2) + 5(10) = 60
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Cont. Scenarios: If consumer’s income = 46, then the optimum is given by combination A. .… Combination B is not affordable If the consumer’s income = 60, then the optimum is given by Combination B….Combination A is affordable but it yields a lower level of utility
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The Ordinal Approach Economists following the lead of Hicks, believe that utility is measurable in an ordinal sense--the utility derived from consuming a good, such as X, is a function of the quantities of X and Y consumed by a consumer. U = f ( X, Y )
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Cont. Ordinal Utility Theory (TUO) Can be measured in qualitative, not quantitative, but only lists the main options (indifference curves & budget line).
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