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A primer on Consumer Choice Finding the optimal choice. Constrained consumer choice. The consumer will want to choose the best bundle within her opportunity set Nothing lying beyond the budget constraint is reachable - PowerPoint PPT Presentation
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Lecture 12 slide 1
A primer on
Consumer Choice
Finding the optimal choice
Lecture 12 slide 2
Constrained consumer choice
The consumer will want to choose the best bundle within her opportunity set
Nothing lying beyond the budget constraint is reachable
We can always find something better that what lies inside the budget constraint...
Lecture 12 slide 3
Figure 4.08a Consumer Maximization
Lecture 12 slide 4
Constrained consumer choice
We want to choose a bundle that lies at the tangency of the budget constraint and the indifference curve
Lecture 12 slide 5
MRS and MRTMarginal Rate of Substitution between pizzas and burritos:
telling us how many burritos we are willing to give up for an extra bit of pizza
and the Marginal Rate of Transformation was the ratio of prices, the slope of the budget constraint ? pZ
pB
MRS = ABAZ
=? MUZ
MUB
Lecture 12 slide 6
Interior solution
The MRS = MRT between pizzas and burritos if we have an interior solution
You will make yourself best-off when you choose your bundle by making equal your, subjective, relative valuation of the goods (MRS) and the, objective, relative valuation of the goods made in the market (MRT)
Lecture 12 slide 7
Interior solution
To understand this remember that we have decreasing MRS
This means that the more pizzas we have relative to burritos, the less we value pizzas relative to burritos
By sliding along our indifference curves or along our budget constraint we would be changing our MRS
When are we going to stop?
Lecture 12 slide 8
Interior solution
Remember the ratio of prices is given (regardless of how much you slide along your indifference curves/budget constraint)
Now imagine you are currently consuming a bundle that makes your MRS pizza-burrito very high
What does it mean?
Well it must mean that according to your own taste you have relative few pizzas if compared to burritos, that makes the MRS high: you would be willing to give away many burritos for a slice of pizza!
Lecture 12 slide 9
Interior solution
So perhaps you are going to choose a bundle with more pizza and less burritos, right?
Because you seem to have now too little pizza and too many burritos to be happy, right?
Go to hidden slide Go to hidden slide
Lecture 12 slide 13
Corner solution
But we can have a corner solution too
This happens when we try to follow our rule of sliding until MRS = MRT but we are stopped by one of the axes
This is because we cannot consume less than 0 pizza nor less than 0 burritos!!!
Lecture 12 slide 14
Figure 4.08b Consumer Maximization
Lecture 12 slide 15
An example
Steven is indifferent between buying books on-line or in a shop: they are the same price and quality
But then the government taxes books in the shop
Lecture 12 slide 16
Solved Problem 4.3
Initially ANY point on I2 will be the best for him
After the tax, he will obviously choose to shop only on-line!…as suggested by the new budget constraint L*
Lecture 12 slide 18
Figure 4.09a Optimal Bundles on Convex Sections of Indifference Curves
Lecture 12 slide 19
Figure 4.09b Optimal Bundles on Convex Sections of Indifference Curves
Lecture 12 slide 20
Next
Deriving Demand Curves
The price-consumption curve
The income-consumption curve
The Engel curve
The effects of a price change
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