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Economics 202: Intermediate Microeconomic Theory

Economics 202: Intermediate Microeconomic Theory. 1. Inquiries? 2. No new reading. 3. HW #4 due next class (it’s on the website). Utility Maximization. Maximize utility subject to a budget constraint Demand function: X * = d X (P X , P Y , I)

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Economics 202: Intermediate Microeconomic Theory

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  1. Economics 202: Intermediate Microeconomic Theory 1. Inquiries? 2. No new reading. 3. HW #4 due next class (it’s on the website)

  2. Utility Maximization • Maximize utility subject to a budget constraint • Demand function: X* = dX(PX, PY, I) • Derive demand functions for different utility functions • C-D, quasilinear, perfect substitutes/complements, CES

  3. Expenditure Minimization • Dual problem to “primal” utility max problem • Minimize total expenditure necessary to achieve a given level of utility • Expenditure function: min expenditures = E(PX, PY, U) • Derive expenditure functions for different utility functions • C-D, quasilinear, perfect substitutes/complements, CES

  4. X 4 1 3 2 I Income-Consumption & Engel Curves • Income-consumption (aka, income offer) curve plots optimal (X,Y) bundles as income changes, holding prices constant • Engel curve plots the optimal consumption levels of X as income changes, holding prices constant • 1 = normal, necessity 2 = normal 3 = normal, luxury 4 = inferior • C-D, quasilinear, perfect substitutes/complements

  5. Initial point = X Income and Substitution Effects Normal Good CCG • Substitution Effect  Pch  substitute toward less expensive good   credit hrs Y is to left of X (Y is above X too) Y X Z • Income Effect = a decrease in purchasing power pushes consumption lower, for superior goods  Pch   “purch power”   Dch if normal Z is to left of Y (Z is below Y too) Credit hours • SE: X  Y IE: Y  Z Total effect: X  Z (graphical analysis)

  6. Income and Substitution Effects: Normal Good Price of credit hour • D-curve for a normal good is necessarily downward sloping because the SE and IE reinforce one another (id est, they push consumption in the same direction) • For  Pch , SE  fewer credits IE  fewer credits • For  Pch , SE  more credits IE  more credits b a Demand Q credit hours

  7. Income and Substitution Effects: Inferior Good CCG Substitution Effect  Pub  substitute toward less expensive good   used books  Y is to right of X (Y is also below X too) Z X Income Effect = an increase in purchasing power pushes consumption lower, for inferior  Pub   “purch power”   Dub , if inferior good  Z is to left of Y (Z is above Y too) Y Used books SE: X  Y IE: Y  Z Total effect: X  Z

  8. Price of used books b a D Q used books Income and Substitution Effects:Inferior Good • D-curve for an inferior good is also downward sloping because, although SE and IE work in opposite directions, IE < SE • For  Pub , SE  fewer books IE  more books • For  Pub , SE  more books IE  fewer books • Giffen good is an inferior good for which the IE > SE, creating an UPWARD-sloping D-curve. • No way?! IE is small for most goods, SE likely large for inferior goods. • Way. Irish potato famine.

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