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Chapter 3

Chapter 3 of 'Microeconomics: Theory and Applications' discusses consumer behavior, focusing on preferences, utility, budget constraints, and behavioral economics. It explores the reasons behind the differing popularity of e-books in the U.S. and Germany, and introduces key concepts such as indifference curves and the marginal rate of substitution. The chapter emphasizes that consumers make choices to maximize their utility within their budget constraints.

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0% found this document useful (0 votes)
9 views53 pages

Chapter 3

Chapter 3 of 'Microeconomics: Theory and Applications' discusses consumer behavior, focusing on preferences, utility, budget constraints, and behavioral economics. It explores the reasons behind the differing popularity of e-books in the U.S. and Germany, and introduces key concepts such as indifference curves and the marginal rate of substitution. The chapter emphasizes that consumers make choices to maximize their utility within their budget constraints.

Uploaded by

sophiashiu1112
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 53

Microeconomics: Theory and Applications

with Calculus
Fifth Edition, Global Edition

Chapter 3

A Consumer’s Constrained
Choice

If this is coffee, please bring me some


tea; but if this is tea, please bring me
some coffee.
Abraham Lincoln

Copyright © 2022 Pearson Education Ltd


Chapter 3 Outline
Challenge: Why Americans Buy E-Books and Germans Do
Not
3.1 Preferences
3.2 Utility
3.3 Budget Constraint
3.4 Constrained Consumer Choice
3.5 Behavioral Economics
Challenge Solution

Copyright © 2022 Pearson Education Ltd


Challenge: Why Americans Buy E-
Books and Germans Do Not
• Background:
– E-books accounted for 20% of trade books sold in the
U.S., but only 4.5% in Germany.
• Questions:
– Why are e-books more successful in the U.S. than in
Germany?
– Do Germans prefer reading printed books, while
Americans prefer reading e-books? consummerpreterencese
– Alternatively, do (after-tax) price differences explain the
differences in book formats?

Copyright © 2022 Pearson Education Ltd


Chapter 3: Model of Consumer
Behavior
Assume
3Consumerthesre①
• Premises of the model:
1. Individual tastes or preferences determine the amount
of pleasure people derive from the goods and services
they consume.

2. Consumers face constraints, or limits, on their choices.

3. Consumers maximize their well-being or pleasure from


consumption subject to the0 budget and other constraints
they face. maximize objective function

E¥¥=Ii¥X

Rational consumer → wise


to
spend money /max his/her happiness

Copyright © 2022 Pearson Education Ltd


| |
Bundle of goods °°"
C- ( toooo coke, o ,
o
)
A) (2B 3A)
.
, . .

eg ( 313 ,
I ,

3.1 Preferences (1 of 2)

• To explain consumer behaviour, economists assume that


consumers have a set of tastes or preferences that they
use to guide them in choosing between goods.
•☐
Goods are ranked according to how much pleasure a
-

1313,2A )
consumer gets from consuming each. highpleasune "S -

( 213.3 A)

– Preference relations summarize a consumer's ranking


a is prefer to b

> ! is used to convey strict


– o
= = preference (e.g. a ! b )

weakly prefer to b is either prefer to b least


'

a at
a is or


I –
= is used to convey weak preference equal to b

by a is impossible
= –
I ~ is used to convey indifferent (e.g. a ~ b)

a is equal to b.

Copyright © 2022 Pearson Education Ltd


10A ,
513 )
" "

Preference System
3.1 Preferences (2 of 2) "
¥i¥T ¥
" "
"

Assume axiom -

• Properties of preferences:
1. Completeness 10A ,
513 ) ¥ ( IA 413)
,

▪ When facing a choice between two bundles of goods (e.g.


a and b), a consumer can rank them so that either
a ! b, b ! a, or a ~ b.
2. Transitivity
-

:¥ a→_z
I
▪ Consumers’ rankings are logically consistent in the
sense that if a ! b and b ! c, then a ! c.
3. More is Better →
eg (3A .
3 B) > ( 3A ,
213 )
▪ All else the same, more of a commodity is better than less.
▪ In this regard, a “good” is different than a “bad.”
free disposal Copyright © 2022 Pearson Education Ltd
tYEB
"
"

B- than set
/
more
too
.

3.1 Preference Maps


• Graphical interpretation of consumer preferences over two


goods: elf :S better eis the A better than see
:
'

more

Cyd :S better XEA


"

benchmark
"
: more
x> e
belong
>
I
,
I

I 0k
'
+
> C , T
1 It
. -
9- - - -
f- -

z
.
-
. -

e :
y
:p

Indifference map
µoreisbetter_
Copyright © 2022 Pearson Education Ltd
?⃝
x >e

*
C ① e > y

x
'
C
+
5¥ .
☒ E.TK
"
C
+ Indifference curve
" "

passing through e
e
+


y
✗ Indifference
④ curve

Cne

one
'

c 're

C
+


f-

d

Iz

-4

If d> c d > f- Transitivity


'

Crf def by Indifference


' '

.
curve

f :
'

> d more is better


c> d
transitivity
'

:
B TX - F Ix

✗ X

Cop ,
0 B)

p
3.1 Indifference Curves (1 of 2)
• The set of all bundles of goods that a consumer views as
being equally desirable can be traced out as an
indifference curve.
• Five important properties of indifference curves:
1. Bundles on indifference curves farther from the origin
are preferred to those on indifference curves closer to ✓
the origin.
2. Every bundle lies on an indifference curve.
3. Indifference curves cannot cross.
4. Indifference curves slope downward.
5. Indifference curves cannot be thick.
technical
Copyright © 2022 Pearson Education Ltd
3.1 Indifference Curves (2 of 2)
• Impossible indifference curves:
13A 213)
.

(3.01A ,
2. ☐ I B)
] They can't
in the same

bra '

.
-

Same I Indifference curve

' #
e~b : I b>a - -

more is better
.

e- a -22
- '

bra transitivity
'

* '

b >a : more is better

Copyright © 2022 Pearson Education Ltd


( Apple ,
Banana ) choice

9 = ( 2. 2) ✓(a) = 30 ①
3.2 Utility (1 of 2) D=

( =
( 1. 3)
(3 , 1)
✓ (b)

✓ (c)
=

=
20

25

• Utility refers to a set of numerical values that reflect the relative


rankings of various bundles of goods.
• The utility function is the relationship between utility measures
and every possible bundle of goods.
– Given a specific utility function, you can graph a specific
indifference curve and determine exactly how much utility is
gained from specific consumption choices.
– Example: q1 = pizza and q2 = burritos
±
U = q1q2 =
G. Got
▪ Bundle x contains 16 pizzas and 9 burritos: U ( x ) = 12
▪ Bundle y contains 13 pizzas and 13 burritos: U ( y ) = 13
▪ Thus, ☐
y!x
Copyright © 2022 Pearson Education Ltd
UH
}
=3

0
x >y
es -

u (g) =
is

3.2 Utility (2 of 2)
OXIlikex-uhemorethany.fr
number only for compare

• Utility is an ordinal measure rather than a cardinal one.


– Utility tells us the relative ranking of two things but not
how much more one rank is valued than another.
– We don’t really care that U ( x ) = 12 and U ( y ) = 13
in the previous example; we care that ☐ y ! x. U =qqT ,

– Any utility function that generated y ! x would be


consistent with these preferences.

• A utility function can be transformed into another utility


-

function in such a way that preferences are maintained.


– Positive monotonic transformation

Copyright © 2022 Pearson Education Ltd


U , =q,,qÑ X=( 16,9 )

Y= 113,13 )
Uz=q,,qC

U ,
(d) =
12

y > x
a- (g) =

Uz (d) =
16×9=4212
ysx
Us (g) = 1135
418.84

3.2 Utility and Indifference Curves


• The general utility function (for q1 = pizza and
q2 = burritos) is U = U (q1, q2 )
U=qÑ
2- x
y

→ a

⑨ 2

Copyright © 2022 Pearson Education Ltd


General Utinlity function : Ulq .az ) ,

Indifference curve

A set of bundles such that utility level is the same

for all bundles on the curve

4- =
Ulq ,qa) ,

I want to find of , ,
qz Sit subs .
q > 92
, Into

Ulqi Az) = Ñ

/4=q±q
possible value : 14,4) Gz ;
Convex
downward
curve

slope )
16 -

too
116,1 ) ;
I Ilñ=6)
4=q,±q ? (1/16)
④ =(q±q:p
! 4-
/ •

zlñ=4)
- -
-
l -
- - - - -
• - -

qz=¥
' '
16=9,9 , =/ bqi I 1

! Ari
,

4 16

dd÷= -146)q?=_q¥
y=Ilx)
If G , T 1- unit , Gabby -1¥ unit

Indifference curve
3.2 Willingness to Substitute Between
Goods ÷
¥ P¥¥¥tti÷¥
• Marginal Rate of Substitution (MRS) is the maximum amount
of one good that a consumer will sacrifice (trade) to obtain one
more unit of another good.
– It is the slope at a particular point on the indifference curve
– MRS = dq2 / dq1 5=4 =qqC
1- unit of q

If you ask me
give up
÷
,

,
= -

I need to get unit of qz back .

÷ ?
;
'

! ! ÷
3 b
q
Copyright © 2022 Pearson Education Ltd
← tangent line

µ
I. 7
every peon
untune

)
a

16 - - - -
-
ooo

:
tangent line with the slope =dd÷
÷
÷
÷
For U=q,qC
For particular Indifferce curve

ñ=4
a- it eg
¥•=÷
d¥• -4¥
.

a#
lñq÷
As tangent line
¥ more flatter
negative slope
,,

less
3.2 Marginal Utilities and Marginal Rate of
Substitution for Five Utility Functions
¶U (q1, q2 ) ¶U (q1, q2 ) U1
U left parenthesis q subscript 1, q subscript 2 right U subscript 1 equals start fraction partial differential U left U subscript 2 equals start fraction partial differential U left M R S equals negative U subscript 1 over U subscript 2.
parenthesis parenthesis q subscript 1, q subscript 2 right parenthesis, parenthesis q subscript 1, q subscript 2 right parenthesis,

U (q1, q2 ) U1 = U2 = MRS = -
over partial differential q subscript 1 end fraction. over partial differential q subscript 2 end fraction.

Utility Function
¶q1 ¶q2 U2
iq1 + jq2 i
i q subscript 1 + j q subscript 2. negative i over j.
i j
Perfect substitutes i.j > o -
j
min(iq1, jq2 )
Min left parenthesis i q subscript 1, j q subscript 2 right
Perfect complements parenthesis.
0 0 0
q subscript 1 superscript a, q subscript 2 superscript 1 minus a. a start fraction U left parenthesis q subscript 1, q subscript 2 Left parenthesis 1 minus a right parenthesis start fraction U left Negative start fraction a over 1 minus a end fraction q subscript

U (q1, q2 ) U (q , q ) a q2
right parenthesis over q subscript 1 end fraction. parenthesis q subscript 1, q subscript 2 right parenthesis over q 2 over q subscript 1.

(1 - a ) 1 2
subscript 2 end fraction.

Cobb-Douglas qq a 1-a
a -
1 2
q1 q2 1 - a q1
Left parenthesis q subscript 1 superscript rho plus q subscript 2 Left parenthesis q superscript rho subscript 1 baseline plus q Left parenthesis q superscript rho subscript 1 baseline plus q Negative left parenthesis q subscript 1 over q subscript 2 right

Constant Elasticity of superscript rho right parenthesis superscript 1 over rho. superscript rho subscript 2 baseline right parenthesis superscript rho subscript 2 baseline right parenthesis
r-1
parenthesis superscript rho minus 1.

æq ö
superscript start fraction left parenthesis 1 minus rho right superscript start fraction left parenthesis 1 minus rho right

r
(q + q ) r 1/ r r
(q + q ) r (1-r )/ r r-1
(q1r + q2r )(1-r )/r q2r-1
parenthesis over rho end fraction baseline times q superscript parenthesis over rho end fraction baseline times q superscript
Substitution 1 2 1
rho minus 1 subscript 1 baseline

2 q 1
rho minus 1 subscrupt 2 baseline.

-ç 1 ÷
(CES)
è q2 ø
u left parenthesis q subscript 1 right parenthesis plus q subscript Start fraction d u left parenthesis q subscript 1 right parenthesis Negative start fraction d u left parenthesis q subscript 1 right
2.
du(q1 )
over d q subscript 1 end fraction.
1 du(q1 )
parenthesis over d q subscript 1 end fraction.

Quasilinear
u(q1 ) + q2 -
dq1 dq1

Notes: i > 0, j > 0, 0 < a < 1, ρ ≠ 0, and ρ < 1. We are evaluating the perfect
complements’ indifference curve at its right-angle corner, where it is not
differentiable; hence the formula MRS = -U1 / U2 is not well defined. We arbitrarily
say that the MRS = 0 because no substitution is possible.

Copyright © 2022 Pearson Education Ltd


lt-q.qf-q.to/qI) → As a constant
At bundle 14,4) 4=4

more
will if
How much
my utility increase I consume one

of q ,

5 4) 5114T to 4.472 <


> ( , a- = = >

Mllq ,
= To -4=0.4721 (
discrete
change) .

Ela:-)
÷
MU ,
=

¥ .
=
a.

l > at 14.4) MU ,
t
constant

=L (4)
±
(4) =
I (4)
°

=
d-
q?
±
MV, =
I q,

±
1T¥ =
It :) a. q ,

>o Lo > o > 0

" "

MU
Diminishing
?⃝
sage
y= f- (dirks )
%¥÷
2X , Xz
e.g .

y= +

AX 1
1- 1- Ax .
Ay
=
? AX ,
If
, = =

Ax

Totad?at¥
,
=
,

Mat
pq
MUZT
,

dy<=¥⑦dx< t¥ ,
,
DX .

U =
U (q , ,
qz )

24181,82) 041 G. %)
du = dq ,
+
dqz
2g , 2 G-

on the same indifference curve

du -

- o

I
o =

JG ,
dq ,
+
¥ dqz
>o

MI
dd%-
24/28
Def of MRS
,

.
= =
-
=
-

< ☐

ou /zq , µ Uz
> o
MRS = -
MI not
only for u=q,qC
Mu ,

AS q.T.MU , I

1 MHz depends
e.g .

perfect substitutes 0

For Cobb -

Dog / us .

q?

u= G. ( t.PH

"" )
specific form :
u=q?q ,
( ☐ <✗ < 1)

MU ,
-_ ✗ qi-lqs.HN
Iq (1-2)
-
""
=
aq , ,

=
4%-14-4
Murli a) q ? q?
-
"✗ -4-21
MU ,
-_ ✗
( F.) qitq ,

MU .
-_ ( 1- d) 1¥ )✗
.

dull
*
,
= ✗ 1-(1%4) qzlialq ,
- a- a) -1
Lo

" -4

dYqY-= q.iq
-

✗ a- d) so
,
3.2 Marginal Utility and MRS
• The MRS depends on how much extra utility a consumer
gets from a little more of each good.
– Marginal utility is the extra utility that a consumer gets
from consuming the last unit of a good, holding the
consumption of other goods constant.
¶U Gz
marginal utility of pizza = = U1 dd÷
¶q1 +

• Using calculus to calculate the MRS:


of ,

dq 2 ¶U / ¶q1 U1
MRS = =- =-
dq1 ¶U / ¶q2 U2
Copyright © 2022 Pearson Education Ltd
3.2 Curvature of Indifference
Curves (1 of 4)
• MRS (willingness to trade) diminishes along many typical
indifference curves that are concave
- to the origin.
cover

• Different utility functions generate different indifference


curves: ( 3) l 3) 5 ,
U = 3
,
to .
=) U =3

U ( =
mi n
q , , q a)

U = i q, tj a a

=
of , 1- ofa

g-
= 2

L
① -
-
-

, U= to

Copyright © 2022 Pearson Education Ltd


=-Y=-2"W.
G ^^" "

¥
3.2 Curvature of Indifference 4
-
"

Curves (2 of 4) 1=2,5-1 2-

U( C. G) = 2C 1- G e
-2

• Perfect Substitutes I 1
I 2 ,
– Goods that a consumer is completely indifferent
between
– Example: Clorox (C) and Generic Bleach (G)
U (C,G ) = iC + jG (: > o . 's > o )
– MRS = −2 (constant)
• Perfect Complements
– Goods that are consumed in fixed proportions
slope = - w


– Example: Apple pie (A) and Ice cream (I)
U ( A,V ) = min(iA, jV )
– MRS is undefined
yvertexysb.pe

-_ 0

Copyright © 2022 Pearson Education Ltd


3.2 Curvature of Indifference
Curves (3 of 4)
• Imperfect Substitutes
– Between extreme examples of perfect substitutes and
perfect complements are standard-shaped, convex
indifference curves. ¥ G §¥¥ vice versa

ya
,
,

G. EIT
– Cobb-Douglas utility function .

U ( q1, q2 ) = q1aq21-a
indifference curves never
hit the axes.
– Quasilinear utility function
U ( q1, q2 ) = u(q1 ) + q2 IF tqz
=
w →
two
d¥=o
/ ☒of the axes.
indifference curves hit one
concave <o 45-1*7-17=3143-3-41Movie .tt#.t
Copyright © 2022 Pearson Education Ltd
I
Ula .az/--qiqI'
"

ga
,

s
a)
q.aq.ci
-

a- =

>

>
s
qia )÷a
(
-4
)÷a=(
"
q
.
a-
ai

9. ,

qz=(ñ)÷a(qj¥ qz=f(a.)

=lu¥÷ ñT a- at

d÷ ,
-_ MRS
For Quasi linear

⑥ 2

Ulq , ,
qz) =
tqz
"^ "" "
"
:\ the org'm
= @+ q .
!
i.
a. = a- -
E ֥
Ti Large Gi
Gi Gi
for q =o q ,
= a-
t
,

for 82=0 q =
(Ñ ) '

±q
,

MRS = -

¥ = -

= -

±¥ ,

+ coz
e.g u=

"

Ui-l-7-w://onlybuyq.it/-U.S1-
3.2 Curvature of Indifference
Curves (4 of 4)
• Indifference curves between food and clothing
– At relatively low quantities of food and clothing,
^
Poor indifference curves, I 1,

+
are nearly right angles:
Perfect complements
– At relatively high quantities
T
rich indifference curves, I 4 ,
become flatter: Perfect
substitutes K

Copyright © 2022 Pearson Education Ltd


¥
3.3 Budget Constraint (1 of 2)
• Consumers maximize utility subject to constraints. ÷
• If we assume consumers can’t save and borrow, current
period income determines a consumer’s budget.
• Given prices of pizza (p1) and burritos (p2), and income Y,
the budget line is
Budge equation p1q1 + p2q2 = y q p÷_¥q ,

• Example:
– Assume p1 = $1, p2 = $2 and Y = $50
– Rewrite the budget line equation for easier graphing
(y=mx+b form):
$50 - ($1´ q1 ) 1
q2 = = 25 - q1
$2 2
Copyright © 2022 Pearson Education Ltd
%÷=
jz¥¥¥u
-2
nrs→É¥¥u
3.3 Budget Constraint (2 of 2)
P¥¥¥-ÉÉ¥
• Marginal Rate of Transformation (MRT) is how the
market allows consumers to trade one good for another.
dq 2 p
– It is the slope of the budget line: MRT = =- 1
dq1 p2

e¥-¥,=¥ .

JP ,

Copyright © 2022 Pearson Education Ltd


sokecsnsumerproblem-lat.e #j4-
3.4 Constrained Consumer Choice (1 of 2)
• Consumers maximize their well-being (utility) subject to their
budget constraint.
• The highest indifference curve attainable given the budget is the
consumer’s optimal bundle.
• When the optimal bundle occurs at a point of tangency between
the indifference curve and budget line, this is called an interior
solution.
– Mathematically, MRS = -
U1
U2
p
= - 1 = MRT
p2

$2"
– Rearranging, we can see that the marginal utility per dollar
is equated across goods at the optimum:

uaxulG.io#Y:::ae
U1 U2
=
Sit P
,
q.tl?qz=Y/ p1 p2
Tf , , qz → choice Jari able Copyright © 2022 Pearson Education Ltd
"
solution =
optimal bundle
g. > ,

,
3.4 Constrained Consumer Choice (2 of 2)
• The interior solution that maximizes utility without going
beyond the budget constraint is Bundle e.
• The interior optimum is where MRS = - U1 = - p1 = MRT
U2 p2
Gz Y<#

.

•• I}

• "


I2

# ± .

¥ .
C

G,

Tq
*
,

Copyright © 2022 Pearson Education Ltd


abetter set
I. d
t

I ,

G. =o
,
P, = $1 82=0 13=5/2

MU ,
(o) =
4 , Muz ( o) = 2

First $1 Y÷=4 ,
¥ =L

G. =
¥
MU , (E) =3

2nd $ ¥ =3 ,
¥ =/

a. =L Example :

t bundle C
,

¥ ¥ >
.

take $ from good 2 and

use $ to
good 1
3.4 Constrained Consumer Choice with
Perfect Complements
• The optimal bundle is on the budget line and at the right
angle (i.e. vertex) of an indifference curve.
Q : It is possible to have

µRg= undefined csner solution given


w-minchi.az )
☒ A : No ,
only interior solution can

MRT

Copyright © 2022 Pearson Education Ltd


%
U
quasi -

concave
¥
3.4 Consumer Choice with Calculus (1 of 2)
• Our graphical analysis of consumers’ constrained choices
can be stated mathematically: Problem forced
max U (q1, q2 ) by consumer

q1, q2

s.t.Y = p1q1 + p2q2


• The optimum is still expressed as in the graphical analysis:
U1 p
MRS = - = - 1 = MRT
U2 p2
• These conditions hold if the utility function is quasi-concave,
which implies indifference curves are convex to the origin.
• Solution reveals utility-maximizing values of q1 and q2 as
functions of prices, p1 and p2, and income, Y.
Copyright © 2022 Pearson Education Ltd
"
max
Cf Our
,
u=qiq .

S.tl?q,tPzqz--Y -
. -
-

:>
Solution : MRS =
MRT
=

÷= -

¥
aqa-iq.la =

qiq
a
4- a)
-

÷a,aiqi=P¥ -


- - -

G- =¥ Gi Ñ=¥aPzGz
combine D. ②

¥a Pzcfztpaq =Y ,

( Eat a) Pacer .=Y Éak9n=Y |qz=÷(i-a#


I

Tq ,*=a¥J
"
q¥lt,a¥]
"
q¥=¥
u* ( at ,q¥
"
= (q ,*)a(a.* )
GE =
"F¥
U*=( P ,
.BY )

1%-51 "T¥)
"
=

A Esty
① AF 8¥ ? depends P ,B,Y
sub

]
.
on ,

compare
*
② U* depend on P , ,
Pa ,
Y A Policy 1 and 2

Example

guy ,, y , ,
, , ,
, , , ,
,z ,

f- $1400 17--1 113=3


Policy
'
2 :

BT u
YT u*p
Pit u*t
?⃝
Max U such that =P , Git Pafa ① optimization constraint

Iq .
-94 find g. and qzs . -1 MRS __ MRT

3.4 Consumer Choice with Calculus (2 of 2)


• A second approach to solving constrained utility y± ±¥- optimization
maximization problems is the Lagrangian method:

3 varitomax →

• The critical value of is found through first-order → f'64=0


-

conditions:
-

• Equating the first two of these equations yields:

Copyright © 2022 Pearson Education Ltd


Max
Cfi 142
£ =
objective fn + ✗ ,
( constraint , )

TY Xz ( constraint )

y p,qg,
+
control P Er tpaqz
÷Y= ' ,

variables + X ,
( constraints)
ftp.q.tpaqz W

Lagrangian µuµp, ,

f
e.g
L = Ula ,qz) ,
+ ✗ ( y Hq
-

,
+ Paced)

I =
ula.iq ) .
+ ✗ ( y-Éy
'

2£ JU
=
-
XP =o ①
Iq Jg
- - .

, ,

¥q .
=

¥ ,
-
XP .
-_ o - -
.

@
All =
All
expenditure income

3¥ =
Y -
Roo ,
-

Pzq .
= 0 . -
-

③ B. C is
binding

① U ,
= XP ,
- - -

D
'


' ②
' ¥ =
#
✗Pz
Uz = ✗ Pz . -
.

MRS =
MRT
?⃝
3- good case :

24 hours p=o
T
Max
£ = U (q , ,q .
,q , ) + ✗ (Y -

Rq -1282
,
-

BG } )
,qz,G } 7)
( Gi .

t t t
sleep play study
+ Xz ( qT -

Gz )
11

F. 0 , C : JI = ☐
2hr .

26
left
,

upper bound on ¥I¥ PEE


2L
.

= 0
Iq
I = o
263

¥,=o
70.6
G. =

a¥ p q
, ,
= ay Pzqz = ( 1- a) Y

¥
0.6

3.4 Constrained Consumer Choice÷


• Application: Recorded tracks and live music
– Utility function: U = q10.4q20.6
– Budget constraint: Y = 30 = 0.5q1 + q2 = p1q1 + p2q2
– Optimal choice: q1 = 24, q2 = 18

a. E- ¥ " "
[ so -0.58 G- ]
I q? qi ✗
-

.
= + ,

=÷¥ as
Jg ,
= o 0.4 q ,
-0.6 G?
"
-
✗ ( 0.5)
= 24

¥
,
=o - - -

3¥ . . . ③

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3.4 Constrained Consumer Choice with
Perfect Substitutes steeper .c m¥←%,eG
The the -2 .

small

+

• With perfect substitutes, if the marginal rate of substitution


a.

does not equal the marginal rate of transformations, then


the consumer’s optimal bundle occurs at a corner
solution, bundle b. MRS and MRT constant MRSFMRT

MRS __ MRT
B.C

I
.C

I
→ OR .

overlap any point


of constant I
B.c
.

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I. C
More steeper I. C

more
likely I. c steeper than B. C

B. C

y
( corner solution)
F.
P . T B. C becomes
*
g. ¥
{
=

*
a.
¥
=
o

"


±¥Ñ


*

In general ,
solution is csnrner

either Gi > o or qz 70
I. C

#
q ,
= o

*
±
Pz
3.4 Constrained Consumer Choice with
Quasilinear Preferences
• With quasilinear preferences, if high income (a), then
interior solution. If low income (b), the corner solution
– Utility function: U =o
4q10.5 + q2

– Budget constraint: Y = q1 + q2 = p1q1 + p2q2


not made
can't
but Uz
U
Uz> ,

81=2,82--0solution)
(corner

y=6
"

o o
Not optimality good
allowed is
satisfied
= 2
4 , lfz
G.
=

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?⃝
Max
=④q°
-5
U + q ,
such that f- Pi G. + Booz
& , i 2

MRS =
MRT

U
g.
,
=
P
29 =
I
Pz

D:-( a. o.si
'

I 41¥) -
-
8.*

II I OF =4 q .*=y -4

*
G. =4
solution)
{
For y >4 (Interior
*
g.
=
y -

G. =4
For y< 4
.¥=
¥
*
G.

{ off
=

( corner solution)
= o
3.4 Type of Solution for Five Utility
Functions

Utility Function U (q1, q2 ) Type of Solution


U left parenthesis q subscript 1, q subscript 2 right parenthesis.

Perfect complements min(iq1, jq2 ) interior



Min left parenthesis i q subscript 1, j q subscript 2 right parenthesis.

, I
Cobb-Douglas qq a 1-a interior →

1 2

to
q subscript 1 superscript a q subscript 2 superscript 1 minus a.

* Constant Elasticity of Substitution (q1r + q2r )1/r interior


MRS =/MRT
Left parenthesis q subscript 1 superscript rho plus q subscript 2 superscript rho right
parenthesis superscript 1 over rho.
MRT
Perfect substitutes qMRS=
interior or cornery
iq1 + jq2
i q subscript 1 plus j q subscript 2.

Quasilinear u(q1 ) + q2 interior or corner


u left parenthesis q subscript 1 right parenthesis plus q subscript 2.
Hr
By compare

Notes: i > 0, j > 0, 0 < a < 1, ρ ≠ 0, and ρ < 1.

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3.4 Minimizing Expenditure
• Utility maximization has a dual -
problem in which the
consumer seeks the combination of goods that achieves a
particular level of utility for the least expenditure.

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3.4 Expenditure Minimization with
Calculus
NotconerMid&
• Minimize expenditure, E, subject to the constraint of
holding utility constant:
min E = p1q1 + p2q2
q1, q2

s.t. U = U (q1, q2 )

• The solution of this problem, the expenditure function,


shows the minimum expenditure necessary to achieve a
specified utility level for a given set of prices:

(
E = E p1, p2 ,U )
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R >G
""
"

3.5 Behavioral Economics


• What if consumers are not rational, maximizing individuals?
– Behavioral economics adds insights from psychology and empirical
research on cognition and emotional biases to the rational economic model.
▪ Tests of transitivity: evidence supports transitivity assumption for
adults, but not necessarily for children.
▪ Endowment effect: some evidence that endowments of goods
influence indifference maps, which is not the assumption of
economic models. → consumer places higher value
a good currently owned
on as

compared to a good they considering purchasing .

▪ Salience: evidence that consumers are more sensitive to increases in


pre-tax prices than post-tax price increases from higher ad valorem
taxes.
– Bounded rationality suggests that calculating post-tax prices is
“costly” so some people don’t bother to do it, but they would use
the information if it were provided.

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Challenge Solution
• Max, a German, and Bob, a Yank, have the same
preferences – perfect substitutes. The U.S. relative after-
tax price of e-books is lower than the German relative
after-tax price. Due to the relative price differences, Max
reads printed books, and Bob reads e-books.

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Figure 3.11 Optimal Bundles on Convex
Sections of Indifference Curves

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