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Microeconomics
ECO402
VU
LESSON
8
Note it is
repeated
Consumer
Preferences
Indifference
curves represent
all combinations of market
baskets that provide
the
same
level of satisfaction to a
person.
Consumer
Preferences
Clothing
Combination
B,A,
& D
(units
per week)
yield
the same
B
50
satisfaction
·E
is
preferred to U
H
E
1
40
·U
is
preferred to H
&
1
A
G
30
D
20
U
G
10
Food
10
20
30
40
(units
per week)
Budget
Constraints
The
Budget Line
The
budget line indicates all
combinations of two commodities
for which total
money
spent equals total
income.
The
Budget Line
Let F
equal the amount of food
purchased, and C is the
amount of clothing.
Price of
food = Pf and price of
clothing = Pc
Then Pf F
is the amount of money spent
on food, and PcC is the
amount of
money
spent on clothing.
The
budget line then can be
written:
PFF +
PCC =
I
Clothing
Pc
= $2
Pf =
$1
I
= $80
(units
per
week)
Budget
Line F + 2C = $80
A
(I/PC) = 40
1
B
Slope
=
ΔC/ΔF
= -
=
-
PF/PC
30
2
10
D
20
20
E
10
G
Food
(units
per week)
0
40
60
80
= (I/PF)
20
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Microeconomics
ECO402
VU
Consumer
Choice
Consumers
choose a combination of goods
that will maximize the
satisfaction they can
achieve,
given the limited budget
available to them.
The
maximizing market basket
must satisfy two
conditions:
1)
It
must be located on the
budget line.
2)
Must
give the consumer the
most preferred combination of
goods and
services.
Recall,
the slope of an indifference
curve is:
Δ C
=
-
MRS
Δ F
Further,
the slope of the budget
line is:
P
F
= -
Slope
P
C
Therefore,
it can be said that
satisfaction is maximized
where:
P F
=
MRS
P C
Pc
= $2
Pf =
$1
I=
Clothing
$80
(units
per
week)
At
market basket A
the
budget line and
40
the
indifference
curve are
tangent
and no higher
level
of satisfaction
30
can
be attained.
A
At
A:
20
MRS
=Pf/Pc =
5
U
Budget
Line
0
20
40
80
Food
(units per
week)
Designing
New Automobiles (II)
Consider
two groups of consumers,
each wishing to spend
$10,000 on the
styling
and performance of
cars.
Each
group has different
preferences.
By
finding the point of
tangency between a group's
indifference curve and
the
budget
constraint auto companies
can design a production and
marketing plan.
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Microeconomics
ECO402
VU
Styling
These
consumers
$10,000
are
willing to trade
off
a considerable
amount
of styling
for
some additional
performance
$3,000
$10,000
Performance
$7,000
Styling
These
consumers
$10,000
are
willing to trade
off
a considerable
amount
of
$7,000
performance
for
some
additional
styling
$10,000
Performance
$3,00
Consumer
Choice
Decision
making & Public
Policy
Choosing
between a non-matching and
matching grant to fund
police
expenditures
Non-matching
Grant
Private
Expenditures
($)
Before
Grant
·
Budget
line: PQ
P
·A:
Preference maximizing
market
basket
·Expenditure
A
R
·OR:
Private
·OS:
Police
U
Police
O
Q
S
Expenditures
($)
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Microeconomics
ECO402
VU
Non-matching
Grant
Private
Expenditures
($)
T
After
Grant
·
Budget
line: TV
P
·B: Preference
maximizing
market
basket
B
U
·Expenditure
A
R
U
·OU:
Private
·OZ:
Police
U
Police
Z
V
O
S
Q
Expenditures
($)
Private
Before
Grant
Expenditures
($)
·
Budget
line: PQ
Matching
Grant
·
A: Preference
maximizing
T
market
basket
After
Grant
·C: Preference
maximizing
P
market
basket
Expenditures
·OW: Private
A
W
·OX: Police
R
C
U2
U1
S
O
Q
R
X
Police
($)
Private
Expenditures
($)
Matching
Grant
T
Non-matching
Grant
·Point B
P
·OU: Private
expenditure
·OZ: Police
expenditure
B
U
Matching
Grant
W
A
U
C
·Point C
U2
·OW: Private
expenditure
U
·OX: Police
expenditure
O
Q
R
Z X
Police
($)
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Microeconomics
ECO402
VU
Revealed
Preferences
If
we know the choices a
consumer has made, we can
determine what her
preferences
are
if we have information about a
sufficient number of choices
that are made
when
prices
and incomes vary.
Revealed
Preferences--Two Budget
Lines
I1:
Chose A over B
l1
Clothing
A
is revealed preferred to B
(units
per
l2:
Choose B over D
month)
B
is revealed preferred to D
l
A
B
D
Food
(units per month)
l
Clothing
(units
per
All
market baskets
month)
in
the blue
shaded
area are
preferred
to A.
l
A
B
D
B
is preferred to
all
market baskets
in
the pink area
Food
(units per month)
Revealed
Preferences--Four Budget
Lines
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Microeconomics
ECO402
VU
I3: E revealed preferred to
A
Clothing
l3
(units
per
month)
All
market baskets in
the
blue
area preferred to A
E
l1
l4
A
l2
G
B
A:
preferred to all
I4:
G revealed preferred to A
market
baskets in
the
pink area
Food
(units per month)
Scenario
·Roberta's recreation budget
= $100/wk
Other
Recreational
·Price of exercise =
$4/hr/week
Activities
·Exercises 10 hrs/wk at
A
given
U &
I
($)
1
1
100
C
·The rate changes to
$1/hr +
$30/wk
80
·New budget line
I
&
2
60
combination
B
A
B
·Reveal preference of
B
to
A
40
U1
U2
Would
the Club's
profits
increase?
20
l
l
Amount
of Exercise
0
50
75
25
(hours)
40