Budget and Utility
- Substitute one good for the other, utility goes up.
- But at one point give up so much and consume so much of the other one, total utility will go down
o B/c not consuming good that you really lik
- Implies that if you were to take budget line or budget constraint (certain amount of income), and
you spend it all on one thing, can only eat that thing
- Can consume everything on that line. If below, then not using all income.
- Assumption is that there’s no saving involved and using all income
- So max utility highest is where slope of utility function is 0 (where it turns)
- At C, can have 2pounds of clams and 6 pounds of potatoes
- Has to consume food and clothing. Same idea
- Indifference curve: at all levels, you get same utility. Same amount of satisfaction on all points
- Constant utility but what’s changing is the purchase of two goods that give you utility
- Allows you to graph utility fxn (the indifference curve)
- From f to d, diminishing clothes. B/c don’t want too much of one thing
- He’s unwilling to give up extra unit of food for clothing
- But along curve, utility/satisfaction is same
But better way to represent utility fxn on graph
- Problem with before is two variables on same axis
- Better if utility curve represented where Y is potato and X axis is clams.
- MU /x = xU /P . yveyy dollar you spend gives you the same extra utility.
- MU /xU = Py/P = xaryinal rate of substitution
- MU /xU is ylope of indifference curve. Slope is the marginal rate of substitution between x and y
- Budget constraint: I = P X x P +Y y
o Budget line simply downward sloped line. Slope is P /P
- You will consume where Marginal rate of substitution is equal to slope of the budget line
o Tangency of budget line and indifference curve
- If budget increase, then consuming more of both goods. Travelling to higher indifference curve
- If price of X goes down, indifference curve becomes flatter
- If keep changing price of X, how does consumption of X change as P changes, gixen your
- Budget line pivots…so how does consumption change?
- Price-consumption line = demand curve?
o Determined by tangency of indifference curve and budget line. Keep doing that until can
map out demand curve
- Two effects: when price of good goes down…
o 1. B/c of lower price, will consume more of that good and less of the other good
- Substitution Effect: If price of gas goes down, what will it take for you to remain on same
o Is the