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Chapter 21-the theory of consumer choice.docx

6 Pages

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ECN 104
Vikraman Baskaran

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Chapter 21 – The Theory of Consumer Choice - People face trade-offs. (from Chapter One) o Buying more than one good leaves less income to buy other goods. o Working more hours means more income and more consumption, but less leisure time. o Reducing saving allows more consumption today but reduces future consumption. o Spends more income on present and saves less of it. The Budget Constraint: What the consumer can afford - Budget constraint – the limit on the consumption bundles that a consumer can afford o Example: Hurley divides his income between two goods: fish and mangos o A “consumption bundle” is a particular combination of goods, e.g., 40 fish & 300 mangos. Representing Preferences with Indifference Curves - Consumer indifference curve – a curve that shows the various bundles of goods that make the consumer equally happy. o Points on higher indifference curves are preferred to points on lower indifference curves. o The slope of an indifference curve at any point is the consumer marginal rate of substitution- the rate at which the consumer is willing to trade one good for another. Four Properties of Indifference Curves - Property 1: Higher indifference curves are preferred lower ones. - Property 2: Indifference curves are downward sloping. - Property 3: Indifference curves do not exist. - Property 4: Indifference curves are bowed inward. One Extreme Case: Perfect Substitutes Another Extreme Case: Perfect Complements Less Extreme Cases: Close Substitutes and Close Complements Optimization: What the Consumer Chooses - The consumer optimizes by choosing the point on his budge
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