Unit1- 6 Consumer Theory
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Transcript of Unit1- 6 Consumer Theory
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What is Consumer
make purposeful choices.
ssumes a consumers un ers an e r
choices (possibilities) and the pricesoppor un y cos s assoc a e w eac
choice.
Assumes that consumers consider thealternatives and choose the one they like best.
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to understand the foundations of market
scratch)
theory issues that are best understood
usin this model rather than the a re ate
demand model
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Two Components of
What can the consumer afford?
a are e consump on poss es
Summarized by the budget constraintPreferences:
What does the consumer like?
How much does a consumer like a good?
Summarized by the utility function
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What is a Budget
consumers purchase opportunities as
be bought at given prices using a given.
The budget constraint measures the
com na ons o purc ases a a personcan afford to make with a given amount
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o mone ary ncome.
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preferences.
mong wo un es, e one w e
higher utility is the preferred bundle. If two bundles have the same utility, we
say that the consumer is indifferent.
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Preferences that satisfy the conditions I have
noted above can be represented byindifference curves.
The set of all indifference curves that describe
an individuals preferences are referred to as.
An indifference curve connects all of the
.We will assume only two goods when using
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Indifference Curve Map -
up.
n erence curves can no cross one
another.Better bundles are to the northeast.
Indifference curves will not be bowed
out.
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Preferences in
An indifference curve connects Li's Indifference Curvesall the bundles that have the
same utility.
Higher indifference curves 25
30
indicate more utility (IC2 is
preferred to IC1).
Lower indifference curves15
20
Rice
I2
I1
I0
indicate less utility (IC1 is
preferred to IC0).
The indifference curve map is0
5
FULL of indifference curves. Wheat
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The Marginal Rate of
The Marginal Rate ofLi's Indifference Curves
how much of one good aperson would willingly tradefor an incremental unit of the 25
30
other good and remainindifferent.
The MRS=|slope| of the15
20
R
ice
I2
I1
I0
n erence curve a abundle.
Common to assume the MRS 0
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an indifference curve. Wheat
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How Much Wheat and
consume is the amount that maximizesutilit sub ect to bud et constraint.
In the graph...
Get to the hi hest indifference curve ossible
Stay on the budget constraint (b/c more is
e er
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How to Find the Best
Rice The black bundle is
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best. The pink bundle is
not the best. All
the income has
IC1
IC2
R*
not on the highest
Wheat10
IC0
W*
possible.
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How to Find the Best
the indifference curve is just tangent to the budgetline.
Utility is maximized when:
you are on the budget line and
the slope of the indifference curve equals the
slope of the budget line
y s max m ze w en: Income=PRR + PWW
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Income and Substitution
on the quantity demanded into an income and asubstitution effect.
Income effect: due to the increase in real income
associated with a fall in prices (you can buy more with
the same nominal income or the loss of real income
associated with a rise in prices (you cannot buy as much
as you once did with the same nominal income).
u s u on e ec : ue o e c ange n e re a veprice of the good, cheaper goods are substituted for
more expensive ones.
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