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2.0. Modeling Individual Choice. Robinson Crusoe - Why?. 2.1. This chapter is about individual choice Crusoe is alone He makes his choices independently Once we understand independent choice, we can move to more complex, interdependent choice. 2.21 Assumptions. No scarcity

katell-williamson
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  1. 2.0 Modeling Individual Choice

  2. Robinson Crusoe - Why?

  3. 2.1 This chapter is about individual choice Crusoe is alone He makes his choices independently Once we understand independent choice, we can move to more complex, interdependent choice

  4. 2.21 Assumptions No scarcity No production is necessary No future or sense of time passing No risk or uncertainty

  5. 2.2.2 Definitions Utility - Satisfaction Consume - the act of deriving utility Note: not always using up. Consume pizza - gone Consume art - still there

  6. tangible, can be stored Ex. Food, sneakers Services - intangible, cannot be stored Ex. Haircut Goods -

  7. 2.2.3 More Assumptions people know what gives them utility, and can rank items by the utility they receive from an item Rational behavior - utility maximizing Assumption - people are rational

  8. Rational households consume goods and services in order to derive the maximum utility

  9. 2.3 Diminishing Marginal Utility

  10. Ceteris paribus, the utility one derives from the consumption of a good decreases with each successive unit consumed Ex. Dying of thirst 1st sip - much utility 2nd sip - less so eventually - no utility New assumption

  11. Ceteris paribus, the utility one derives from the consumption of a good decreases with each successive unit consumed or one experiences diminishing marginal utility More clearly stated:

  12. 2.32 Marginal and Total Utility We can make up a unit of utility we’ll call it a util Chart on page 20 Eventually, as you keep eating you get to the point where you derive no satisfaction At this point, MU=0

  13. Example - Big Bowl of M&Ms

  14. Marginal Utility with Multiple Choices Different activities will have different MU lines

  15. 2.4 Constructing a decision rule

  16. 2.4.1 Initial Decision Rule MU1=MU2=MU3=…=MUn=0 If you can get to the point where you have totally satisfied yourself in all dimensions of consumption, That is called a bliss point Absolute maximum utility has been attained

  17. This rule is valid only given the strong assumptions we have chosen While not totally realistic, it gives us a starting point from which to build

  18. 2.5 Relaxing the “No Scarcity” Assumption

  19. If time were not scarce, You could think of the decision rule as

  20. We will now assume time to be scarce This is much more realistic Can’t do everything to satiate yourself Suppose the only things you have time to do are study and play, and you only have ten hours

  21. An initial allocation 7 hours of play – MU=50 3 hours of study – MU=70

  22. How to optimize- the optimal allocation is the one which maximizes utility Do another hour of the choice which gives you the higher marginal utility

  23. A new allocation 6 hours of play – MU=60 4 hours of study – MU=60

  24. What you now have is a new rule Where X can be >0

  25. This new rule describes how people solve a constrained optimization problem In other words, how do people maximize utility in the face of scarcity?

  26. 2.6 Relaxing the “No production necessary” assumption

  27. In reality, Stuff doesn’t just appear like magic for you to consume Endowment- all the natural and human resources from which all goods and services are produces Endowment may not be fixed, but it is finite, so scarcity is an issue (We discover new oil all the time, but there is an ultimate limit)

  28. More new terms Factors of production are allocated to and then combined in processes of production that apply techniques chosen from available technology in order to produce goods and services

  29. 2.6.2 On factors Factors of production – basic inputs we use to produce, such as Natural resources – in, on or around the earth Labor- human work Together, these first two are called the natural endowment

  30. Another factor is capital “a produced means of production” More properly called production capital Physical capital –tools, machines Human capital – inside yourself, allows you to be more productive – education

  31. 2.6.3 Allocation, Techniques, and Technology Allocated – we decide how to use the factors Process of production – transforming the inputs into an good, or service Technique- one way of combining inputs Technology – set of all available techniques

  32. Types of techniques Labor-intensive technique- uses primarily labor Capital-intensive technique – uses primarily capital Firms usually choose the cheapest way

  33. 2.6.5 Scale of Production Refers to the size of the process of production Returns to scale – how does a change in scale affect output? Ex. If double inputs – less than doubles the output –decreasing returns to scale If double inputs – doubles the output – constant returns to scale If double inputs - more than doubles the output – increasing returns to scale We assume decreasing returns to scale

  34. 2.6.6 Marginal Productivity The additional output that comes from an additional unit of input is called the marginal product While MP can increase for a while, It will eventually diminish If inputs were free, to maximize production you would use inputs until MP=0 for all inputs

  35. 2.6.7 Value from the marginal product – V So far, we have two independent rules: MU1=MU2=MU3=…=MUn=0 (consumption of free goods) MP1= MP2 = MP3=…=MPn=0 (use of free inputs) Now we need to bridge the two

  36. we must find out what the utility is for the last unit of labor towards a given product this is called the Value of the Marginal Product, or V To connect the two sides,

  37. 2.6.8 How to calculate V

  38. You need a marginal product schedule

  39. You need a marginal utility schedule

  40. Calculating V

  41. 2.6.9 Why Value Marginal product eventually falls V eventually falls because MU falls from unit 1 MP eventually falls

  42. 2.6.10 V and optimization If R.C. had V schedules for each activity, he could decide on the “optimal” or best allocation of his labor Because he is rational, he chooses activities that give him the maximum utility

  43. V schedules

  44. How many hours To get every last util? 23

  45. What if there was a time constraint of 13 hours of daylight? Answer: Hunt - 4 hours Fish - 5 hours Pick Berries - 2 hours Pump Water - 2 hours

  46. Decision rule Time is perfectly divisible, so you can always reconfigure with smaller units of time until this works out

  47. 2.6.11 The General decision rule V1=V2=V3=…=Vn=X X>0

  48. 2.6.12Changing constraints Assume winter comes, so no berries are available And there is only 7 hours of daylight

  49. 2.6.13 Conclusion on V We are trying to build a model to describe how people make choices Whether it is done consciously or not, people do allocate their scarce resources according to some process Given our assumptions, people will follow the rule we have developed

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