Econ 410: Micro TheoryBudget Constraints & Consumer ChoiceWednesday, September 5th, 2007The Plan for Today Homework Debrief Budget Constraints In what ways can we integrate the idea of scarcity into consumer behavior? How can we use a budget line to model this scarcity? Consumer Choice Given a limited budget, what do the optimal choices of consumers look like? Revealed Preference If we don’t see people’s indifference curves, how can we know anything about them?Homework Debrief Clarifications All work you turn in must be your own When you quote the textbook, cite it Things to improve upon for next time Label Everything! Explanations are a great way to earn partial credit Make your answers clearRecall from last time… We can graph preferences using indifference curves The MRS is the slope of an indifference curve, and provides a measure of the ways in which people choose between two goods We can quantify preferences by using utility functions Assigning a level of utility to each market basket Utility in this context is ordinalBudget Constraints People have limits A budget constraint is a type of limit that people face as a result of income. Quantifying Budget Constraints Initial assumptions The budget line Example – Beer, Pizza, and Parents I = pz?Z + pB?B 50 = 10 ?Z + 15 ?BGraphing the Budget LineBundle Beer Pizzaa 0 5b 1 3.5c 2 2d 3 0.5Allocations of a $50 budget between beer and pizzaChanges in Prices & Income The slope of the budget line is the price ratio of the two goods Slope = B/P = -PZ/PBIncome Changes Suppose a student’s monthly allowance changes from $50 to $100. What happens to the budget line? Algebraically? Graphically?Changes in Prices & Income Price Changes Suppose the price of a pizza doubles from $10 to $20What happens to the budget line? Algebraically? Graphically?Consumer Choice In economics, we assume that: Consumers choose a bundle that maximizes their satisfaction given a limited budget The utility-maximizing market basket must: Be located on the budget line Give the consumer the bundle of goods & services that attains the highest level of utility possible (is most preferred)Consumer Choice How do we satisfy these conditions graphically?Consumer Choice What is true algebraically about the optimal consumption bundle? MRS (of Z for B) = PZ/PBMarginal Analysis Marginal Benefit Marginal Cost Relationship to the marginal rate of substitutionCorner Solutions When consumers buy in extremes, the optimal bundle is often a corner solution When this occurs, the MRS does not necessarily equal the price ratio Example Lauren likes ice cream much more than any other food – if she had any other food lying around her house, she would probably trade it for ice cream What will her preferences look like?Corner Solutions Example Lauren likes ice cream much more than any other food – if she had any other food lying around her house, she would probably trade it for ice cream In this case: MRS < PO/PIRevealed Preference We know how to represent an individual’s preferences if given a utility function or an indifference mapBut… What if, instead, we only have information about the choices consumers make at various prices and income levels? Revealed Preference is a way to use this information to find out moreRevealed Preference The basics: If a consumer chooses bundle A over bundle B, And… Bundle A is more expensive than bundle BThen… Bundle A is revealed preferred to bundle B How can we use revealed preference to compare other bundles?Revealed Preference Choices after a shift in income or prices reveal a consumer’s preference for one good over another ExampleFor next time… Friday’s Agenda After the quiz, we’ll discuss the concept of marginal utility and how it relates to optimal consumer choices We’ll begin looking at all of these ideas from a more mathematical perspective Read section 3.5, and pages 145-152 in Chapter 4 (the appendix) Quiz - This Friday over Sections 3.1-3.3 Study the book carefully, focusing on the topics that have been covered in
View Full Document
Unlocking...