Chapter 5

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# Chapter 5 - PowerPoint PPT Presentation

Chapter 5 . Choice of consumption. Optimal choice is at the point in the budget line with highest utility. The tangency solution of an indifferent curve and the budget line: MRS = – p 1 / p 2 . Fig. Basic equations: MU 1 / p 1 = MU 2 / p 2 and

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Presentation Transcript
Chapter 5

Choice of consumption

Optimal choice is at the point in the budget line with highest utility.
• Thetangencysolution of an indifferent curve and the budget line:

MRS = – p1 / p2.

Fig.

Basic equations:
• MU1 / p1 = MU2 / p2and
• p1 x1 + p2 x2 = m.

Figs.

• ( How if negative solutions.)
Interiorsolutions, and
• Boundary (Corner) solutions.
• Kinky tastes.

Figs.

Three approaches to

the basic equations:

• Graphically;
• As-one-variable;
• *Lagrangian.
Examples:
• perfect substitutes,
• perfect complements,
• concave preferences.

Figs.

Cobb-Douglas demand functions.
• * Choosing taxes.

(By *Slutsky decomposition.)

Figs.

Demand functions:
• x1 = x1 (p1, p2, m),
• x2 = x2 (p1, p2, m).
Normaland inferiorgoods (by income); Fig.
• Luxury and necessarygoods (by income). Fig.
• Ordinary and Giffen goods (by price). Fig.
The income expansion path

or the income offer curves,

• and the Engel curve.

Figs.

The price offer curve
• and the Demand curve.

Figs.

Substitutes and complements.
• Cobb-Douglas preferences.
• Quasilinear preferences.
* Homothetic preferences:

if (x1, x2) is preferred to (y1, y2),

then (tx1, tx2) is preferred to

(ty1, ty2) for any t > 0.

• Thus both the income offer curves and the Engel curves are all rays through the origin.
Example:
• Quasilinear preferences