ECON 401 Chapter Notes - Chapter 5: Budget Constraint, Indifference Curve, Tangent
Chapter 5: Choice
• Combining budget set and the theory of preferences in order to examine the optimal
choice of consumers
• Consumer choose the most preferred bundle from their budget sets
5.1 Optimal Choice
• Find the bundle in the budget set that is on the highest indifference curve.
• As you move along the budget line, we move to higher and higher indifference curves
• Optimal choice =
= bundle of goods that is associated with the highest
indifference curve that just touches the budget line = where the indifference curve is
tangent to the budget line normal case called interior optimum (slope of the
indifference curve = slope of the budget line = MRS)
• THE ONLY CASE WHERE TANGENCY IS SUFFICIENT CONDITION FOR THE BUNDLE TO BE
OPTIMAL = STRICTLY CONVEX INDIFFERENCE CURVE OR INTERIOR OPTIMUM
• The set of bundles a consumer prefers to
is above the indifference curve and
budget line
• Tagey does’t hold i all ases
o Indifference curve might not have a tangent, but still can never cross the budget
line
o Kinky tastes:
o
o Boundary optimum:
o
• What is the indifference curves have multiple tangencies?
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o
• MRS = slope of udget lie at a iterior optiu… Eooi ipliatios
o MRS = rate of exchange at which the consumer is willing to stay put =
o BUT whenever the MRS is different to the price ratio, the consumer cannot be at
his or her optimal choice
5.2 Consumer Demand
• Demand bundle: a osuer’s optimal choice of goods 1 and 2 at some set of prices and
income
• Whe pries ad ioe hage, the osuer’s optial hoie ill hage
• Demand function: relates optimal choice – the quantities demanded – to the different
values of prices and incomes
o and
o For each set of prices and income, there will be a different combination of goods
that is the optimal choice of the consumer
5.3 Some Examples
• Basic procedure: plot the indifference curves and budget line and find the point where
the highest indifference curve touches the line
Perfect Substitutes
• Optimal choice is where the consumer spends all their money on the cheaper good
• If , there is a whole range of optimal choices – any amount of goods 1 and 2 that
satisfies the budget constraint is optimal
• Demand function for good 1:
o
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ECON 401 Full Course Notes
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Document Summary
Chapter 5: choice: combining budget set and the theory of preferences in order to examine the optimal choice of consumers, consumer choose the most preferred bundle from their budget sets. Optimal = strictly convex indifference curve or interior optimum budget line: ta(cid:374)ge(cid:374)(cid:272)y does(cid:374)"t hold i(cid:374) all (cid:272)ases. 5. 3 some examples: basic procedure: plot the indifference curves and budget line and find the point where the highest indifference curve touches the line. Perfect substitutes satisfies the budget constraint is optimal: demand function for good 1, optimal choice is where the consumer spends all their money on the cheaper good. If (cid:2869)=(cid:2870), there is a whole range of optimal choices any amount of goods 1 and 2 that: (cid:1876)(cid:2869)={ (cid:1853)(cid:1866)(cid:1877) (cid:1866)(cid:1873)(cid:1865)(cid:1854)(cid:1857) (cid:1854)(cid:1857)(cid:1872)(cid:1875)(cid:1857)(cid:1857)(cid:1866) 0 (cid:1853)(cid:1866)(cid:1856) (cid:3117)| (cid:1875) (cid:1857)(cid:1866) (cid:2869)=(cid:2870) (cid:3117)| (cid:1875) (cid:1857)(cid:1866) (cid:2869)