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    Microeconomics: Chapter 5 Choice

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    Rulojy
    The document discusses consumer choice theory and how consumers make choices given budget constraints. It explains that consumers will choose the bundle of goods that maximizes their preferences, which occurs where the indifference curve is tangent to the budget line. This optimal choice can be an interior optimum, where both goods are consumed, or a boundary optimum, where one good has a quantity of zero. The document also discusses different cases like perfect substitutes, perfect complements, neutral/bad goods, and discrete/concave preferences. It introduces demand functions and how demand changes with price and income.

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    Microeconomics: Chapter 5 Choice

    Uploaded by

    Rulojy
    686 views4 pages
    The document discusses consumer choice theory and how consumers make choices given budget constraints. It explains that consumers will choose the bundle of goods that maximizes their preferences, which occurs where the indifference curve is tangent to the budget line. This optimal choice can be an interior optimum, where both goods are consumed, or a boundary optimum, where one good has a quantity of zero. The document also discusses different cases like perfect substitutes, perfect complements, neutral/bad goods, and discrete/concave preferences. It introduces demand functions and how demand changes with price and income.

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    The document discusses consumer choice theory and how consumers make choices given budget constraints. It explains that consumers will choose the bundle of goods that maximizes their preferences, which occurs where the indifference curve is tangent to the budget line. This optimal choice can be an interior optimum, where both goods are consumed, or a boundary optimum, where one good has a quantity of zero. The document also discusses different cases like perfect substitutes, perfect complements, neutral/bad goods, and discrete/concave preferences. It introduces demand functions and how demand changes with price and income.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    686 views4 pages

    Microeconomics: Chapter 5 Choice

    Uploaded by

    Rulojy
    The document discusses consumer choice theory and how consumers make choices given budget constraints. It explains that consumers will choose the bundle of goods that maximizes their preferences, which occurs where the indifference curve is tangent to the budget line. This optimal choice can be an interior optimum, where both goods are consumed, or a boundary optimum, where one good has a quantity of zero. The document also discusses different cases like perfect substitutes, perfect complements, neutral/bad goods, and discrete/concave preferences. It introduces demand functions and how demand changes with price and income.

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    CHAPTER 5 CHOICE

    Consumers choose the most preferred bundle from their budget sets
    We want to find the bundle in the budget set that is on the highest
    indifference curve. Since preferences are well-behaved, so that more
    is preferred to less, we can restrict our attention to bundles of goods
    that lie on the budget line and not worry about those beneath the
    budget line. We stop when we get the indifference curve that just
    touches the budget line. At this choice, the indifference curve is
    tangent to the budget line, the budget line cannot cross with
    the indifference curve because there would be some point on the
    budget line that lies above the indifference curve.
    It doesnt hold for every case (example: kinky tastes) but What is
    always true is that at the optimal point the indifference curve
    cant cross the budget line.
    INTERIOR OPTIMUM AND BOUNDARY
    OPTIMUM
    Boundary
    optimum:
    the
    optimal
    consumption involves consuming zero
    units of good 2. The indifference curve is
    not tangent to the budget line (they have
    different slopes).
    Interior optimum: optimal choice that
    involves consuming some of the both
    goods. If we have an interior optimum
    with smooth indifference curves, the
    slope of the indifference curve and the
    slope of the budget line must be the same.

    On the other hand, tangency condition is necessary but not


    sufficient condition.

    However, there is one important case


    where it is sufficient: the case of
    convex preferences where any point
    that satisfies the tangency condition
    must be an optimal point.
    If the indifference curves are strictly
    convex then there will be only one
    optimal choice on each budget line.
    In order to be coherent, MRS must equal
    the slope of the budget line at an interior
    optimum. More specifically, MRS has to
    be the same as price ratio.
    MRS= x2/x1 = -p1/p2

    CONSUMER DEMAND
    In general when prices and income change, the consumers optimal
    choice will change. The demand function is the function that relates
    the optimal choice to the different values of prices and incomes. We
    will write the demand functions as depending on both prices and
    income: x1(p1, p2,m) and x2(p1, p2,m).
    PERFECT SUBSTITUTES
    x1=
    -

    m/p1 when p1 < p2;


    any number between 0 and m/p1 when p1 = p2;
    0 when p1 > p2.

    CONCLUSION: if two goods are perfect substitutes, then a consumer


    will purchase the cheaper one. If both goods have the same
    price, then the consumer doesnt care which one he or she
    purchases.
    PERFECT COMPLEMENTS
    The optimal choice must always lie on the diagonal, where the
    consumer is purchasing equal amounts of both goods, no matter what
    the prices are.
    Solving the budget constraint:
    If x1=x2=x p1x+p2x=m

    NEUTRALS AND BADS

    x= m/ p1+p2

    In the case of a neutral good


    the consumer spends all of
    her money on the good she
    likes and doesnt purchase
    any of the neutral good.
    Thus, if commodity 1 is a good
    and commodity 2 is a bad, then
    the demand functions will be:
    x1 = m/p1
    x2 = 0
    DISCRETE GOODS

    CONCAVE PREFERENCES
    Example: you have money to purchase
    ice cream and olives but you dont like
    to consume them together. You will
    spend all your money on one or the
    other.

    COBB-DOUGLAS
    X1= (c/c+d) m/p1
    X2= (d/c+d) m/p2
    We can interpret c as the fraction of income spent in good 1. Similarly
    the fraction of his income that the consumer spends on good 2 is d/
    (c+d).

    Important fact about economics: The fact that prices are not arbitrary
    numbers but reflect how people value things on the margin is one of
    the most fundamental and important ideas in economics.

    QUANTITY TAX VS. INCOME TAX

    Quantity tax is a tax on the amount


    consumed of a good.
    Income tax is just a tax on income.
    But shall the government use both
    taxes or the most convenient.
    Quantity
    Tax
    on
    (p1+t)x1+p2x2=m

    good

    1:

    Income TAX: p1x1+p2x2= m- R*

    Lagrange multiplier:
    L = u(x1, x2) (p1x1 + p2x2 m)
    Derivar segn x1 y x2 e imponer la budget constraint como
    restriccin.

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