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Consumer Choice

Consumer Choice. Perloff Chapter 4. Introduction. Demand curve As price of a good increases we buy less of it. Consumers are making a choice What governs the ways in which these choice are made Preferences are central. Assumptions. Completeness

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Consumer Choice

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  1. Consumer Choice Perloff Chapter 4

  2. Introduction • Demand curve • As price of a good increases we buy less of it. • Consumers are making a choice • What governs the ways in which these choice are made • Preferences are central

  3. Assumptions • Completeness • Given any two bundles consumer can always rank them or say he/she is indifferent. • Transitivity • If bundle 1 is preferred to bundle 2 and bundle 2 is preferred to bundle 3 this implies that 1 is preferred to 3. • More is better • Bundles containing more of all goods are preferred

  4. Using transitivity to construct an preference map B , Burritos per semester c A 25 f 20 15 e a d 10 b B 0 15 25 30 Source: Perloff Z , Pizzas per semester

  5. Indifference Curve B , Burritos per semester c 25 f 20 e 15 a d I 10 b 0 15 25 30 Z , Pizzas per semester

  6. Properties 1 and 2 B , Burritos per semester c 25 • Indifference curves further away from the origin are preferred. • There is an indifference curve through every bundle f 20 2 I e 15 d 1 I 10 0 I 0 15 25 30 Z , Pizzas per semester

  7. Property 3 B , Burritos per semester • Indifference curves cannot cross e b 1 I a 0 I Z , Pizzas per semester

  8. Property 4 B , Burritos per semester • Indifference curve slope downwards b a I Z , Pizzas per semester

  9. Property 5 B , Burritos per semester • Indifference curves are convex to the origin a 8 – 3 b 5 1 – 2 c 3 1 d – 1 2 1 I 0 3 4 5 6 Z , Pizzas per semester

  10. Marginal Rate of Substitution B , Burritos per semester • How many burritos will be exchanged for 1 Pizza a 8 -6 5 3 d 2 3 I 0 3 4 5 6 Z , Pizzas per semester

  11. Perfect Substitutes Coke, Cans per week 4 A 3 B 2 C 1 1 2 3 4 I I I I 0 1 2 3 4 Pepsi, Cans per week

  12. Perfect Complements Ice cream, Scoops per week e c 3 3 I b d 2 2 I a 1 1 I 0 1 2 3 Pie, Slices per week

  13. Indifference Curves between Food and Clothing, What is happening? Food at home per year 4 I 3 I 2 I 1 I Clothing per year

  14. Utility • Indicates the position of a bundle of goods in the consumers preference ordering. • Higher ranking implies higher utility. • Preferences are fundamental. • Utility is a simply a useful way of summarising preferences.

  15. Utility Function Mathematical relationship between the quantities of the goods and the level of utility.

  16. The change in utility when the consumption of a good changes by one unit Marginal Utility U , Utils 350 ) Utility function, (10, Z U 250 = U 20 D 230 = 1 Z D 0 1 2 3 4 5 6 7 8 9 10 Z , Pizzas per semester

  17. Diminishing marginal utility MU , Marginal Z utility of pizza 130 20 MU Z 0 1 2 3 4 5 6 7 8 9 10 Z , Pizzas per semester

  18. Budget Constraint A person spends £50, burritos cost £2 and pizzas cost £1, they buy 10 pizzas, how many burritos can they buy? Cost of Pizzas: In general: Money left for burritos: Number of Burritos: Intercept Slope (MRT)

  19. Opportunity Set B , Burritos per semester a = 25 Y / p B b 20 1 L ( p = £1, Y = £50) Z c 10 Opportunity set d 0 10 30 50 = Y / p Z Z , Pizzas per semester

  20. Increase in Price B , Burritos per semester 25 1 L ( p = £1) Z Loss 2 L ( p = £2) Z 0 25 50 Z , Pizzas per semester

  21. Income Increases B , Burritos per semester 50 3 = L ( Y £100) 25 Gain 1 = L ( Y £50) 0 50 100 Z , Pizzas per semester

  22. The optimal choice B , Burritos Budget line per semester g 25 c f 20 B e 10 3 I d 2 I a A 1 I 0 10 30 50 Z , Pizzas per semester

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