Principles and Preferences: Mcgraw-Hill/Irwin
Principles and Preferences: Mcgraw-Hill/Irwin
Principles and Preferences: Mcgraw-Hill/Irwin
McGraw-Hill/Irwin
Main Topics
Principles of decision-making Consumer preferences Substitution between goods Utility Recommended Reading: Applications 4.1, 4.2; Example 4.3
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Indifference Curves
Use when goods are (or assumed to be) available in any fraction of a unit Represent alternatives graphically or mathematically rather than in a table Starting with any alternative, an indifference curve shows all the other alternatives a consumer likes equally well
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Rates of Substitution
Consider moving along an indifference curve, from one bundle to another This is the same as subtracting units of one good and compensating the consumer for the loss by adding units of another good Slope of the indifference curve shows how much of the second good is needed to make up for the decrease in the first good
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MRS XY Y X
Tells us how much Y a consumer needs to compensate for losing a little bit of X Tells us how much Y to take away to compensate for gaining a little bit of X
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Utility
Summarizes everything that is known about a consumers preferences Utility is a numeric value indicating the consumers relative well-being Recall that the consumers goal is to benefit from the goods and services she uses Can describe the value a consumer gets from consumption bundles mathematically through a utility function
U S , B 2S 5S B
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Marginal Utility
To make a link between MRS and utility, need a new concept Marginal utility is the change in a consumers utility resulting from the addition of a very small amount of some good, divided by the amount added
MU X U X
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Marginal Utility
Using Calculus, marginal utility of X in the change in U when X changes by a very small amount.
U MU X X
Small change in X, X, causes utility to change by MUXX Small change in Y, Y, causes utility to change by MUYY If we stay on same indifference curve, then Y/X =MUX/MUY
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