Unit 1.2 2016 students.pdf

8/17/2019 Unit 1.2 2016 students.pdf

1/22


2/22

Outcomes• Define, explain and illustrate how the budget constraint

(and the slope) can change.

• Discuss the characteristics of consumer preferences• Define, illustrate and discuss the different charateristics

of indifference curves.• Calculate, illustrate and explain the slope and change in

the budget line.• Use a graph to illustrate the consumer’s equilibrium.• Explain and illustrate the difference between the income

and substitutuion effect by using indifference curves.• Derive the demand curve by using the indifference

approach.• Apply the rational choice model.


3/22

Properties of Preference

Orderings

• Completeness : the consumer is able to rank

all possible combinations of goods andservices.

• More-Is-Better : other things equal, more of a

good is preferred to less.

• Transitivity : for any three bundles A, B, and

C, if one prefers A to B and prefers B to C,

then one always prefers A to C.

• Covexity : mixtures of goods are preferable to

extremes.


4/22

Figure 3.1: Generating Equally

Preferred Bundles


5/22

Indifference Curves• Indifference curve : a set of bundles

among which the consumer is indifferent.

• Indifference map : a representativesample of the set of a consumer’sindifference curves, used as a graphical

summary of her preference ordering.


6/22

Properties of Indifference

Curves• Indifference curves …

1. Are Ubiquitous.Any bundle has an indifference curve passing through it.

2. Are Downward-sloping.This comes from the “more-is-better” assumption.

3. Cannot cross.

4. Become less steep as we move downward and to theright along them.

This property is implied by the convexity property of

preferences.


7/22

Trade-offs Between Goods• Marginal rate of substitution (MRS): the

rate at which the consumer is willing toexchange the good measured along thevertical axis for the good measured alongthe horizontal axis.

– Equal to the absolute value of the slope of the

indifference curve.


8/22

Figure 3.2: An Indifference Curve


9/22

Fig. 3.7: People have different tastes


10/22

Figure 3.10: Part of an Indifference

Map

0


11/22

Figure 3.13: Why Two Indifference

Curves Do Not Cross

0


12/22

Figure 3.14: The Marginal Rate

of Substitution

0


13/22

Figure 3.15: Diminishing Marginal

Rate of Substitution


14/22

Budget constraint

• Definition:

– All the combinations

(bundles) of 2 goods aperson can purchase givena certain money incomeand prices for the twogoods.

– Any point on budgetconstrain (and below)represents possiblecombinations.

• Slope = relative prices of

two goods, X and Y

(Px/Py).

• Changes in budgetconstraint:

– Relative prices changes :budget constraint revolves(rotates) away or towardsorigin

• Number of bundlesavailable increases ordecreases

– Individuals incomechanges: budget constraintmoves parallel towards oraway from origin.


15/22

Figure 3.8: The Budget Line,

or Budget Constraint


16/22

Budget shifts due to price or income

changes

• If the price of ONLY one good changes…

– The slope of the budget constraint changes.

• If the price of both goods change by the sameproportion…

– The budget constraint shifts parallel to the originalone.

• If income changes ….

– The budget constraint shifts parallel to the original

one.


17/22

Figure 3.10: The Effect of a Rise

in the Price of Shelter


18/22

Figure 3.11: The Effect of Cutting

Income by Half


19/22

The Best Feasible Bundle• Consumer’s Goal : to choose the best

affordable bundle. – The same as reaching the highest indifference

curve she can, given her budget constraint.

– For convex indifference curves.

• the best bundle will always lie at the point oftangency between the budget line and theindifference curve.


20/22

Figure 3.17: The Best Affordable Bundle


21/22

Calculation of optimal bundle• Example: pg 92 -95

• Optimal bumdle where U =XY, Px = 4, Py= 2 and M = 40


22/22

Figure 3.25: The Optimal Bundle when

U = XY, P x = 4, P y = 2, and M = 40

0

Documents

Unit 1.2 2016 students.pdf