ECON201 Lecture Notes - Lecture 3: Price Drop, Marginal Utility, Convex Preferences

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9 Aug 2016
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ECON 201 – Chapter #3 Notes
Consumer Preferences tell us how the consumer would rank (that is, compare the
desirability of) any two combinations or allotments of goods, assuming these combinations
were available to the consumer at no cost.
How the consumer would rank (or compare) any 2 combination(s) of goods
Some Basic Assumptions about Preferences
1. Completeness - For any two market baskets A and B, a consumer will prefer A to B,
will prefer B to A, or will be indifferent between the two.
2. Transitivity - If a consumer prefers basket A to basket B and basket B to basket C,
then the consumer also prefers A to C
3. More is better - Consumers always prefer more of any good to less.
indifference curve is the set of all baskets for which the consumer is indifferent (each
basket generates the same level of satisfaction).
Along the indifference curve, if you consume any basket, you get the same about of
happiness
Indifference map illustrates a set of indifference curves for a consumer
Assuming that U3 is above U2 and U2 is above U1, then:
Any market basket on indifference curve U3, such as basket A, is preferred to any basket on
curve U2 (e.g., basket B), which in turn is preferred to any basket on U1, such as D.  U3 is
preferred to U1, it represents a higher level of satisfaction
Facts:
Indifference curves cannot cross because it does not respect (violates) ALL the
rules – transitivity, completeness, and more is better
Indifference curves have negative slope (Downward sloping) – and indifference
curves are not “thick”. IF they ARE thick then that means you’re able to find 2 points
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Indifference curves are convex (bowed inward) AVERAGES PREFERRED TO
EXTREMES. This means that you like both goods, and you prefer more to less
Marginal rate of substitution (MRS) is the amount of a good (on the vertical axis) that a
consumer is willing to give up in order to obtain one additional unit of another good (on
the horizontal axis).
Negative Slope
Facts:
MRS is diminishing because the more of good you have, the less of the good you will
give up to get another unit of the same good
MRS is decreasing along the Indifference curve
It will never touch the axis
MRS is the negative of the slope of the indifference curve
Diminishing marginal rate of substitution: When the MRS diminishes along an
indifference curve, the curve is convex.
There are special cases however:
Perfect Complements – Two goods for Perfect Substitutes - Two goods for
Which MRS are 0 or infinite which the marginal rate of
substitution of one for the other is a
constant.
A. B.
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In A., left shoes and right shoes are perfect complements: An additional left shoe gives Bob
no extra satisfaction unless he obtains the matching right shoe.
In B., Bob is always indifferent between a glass of apple juice and a glass of the orange
juice. What is the MRS?  Constant
As we can see:
Any 2 points you can compare, so your preferences are complete
Not convex  Averages are NOT preferred to extremes
Happiness is driven by the amount of x you consume
Here we clearly only care about x, y is neutral --> doesn’t’t matter how many
units of y you have to give up  Neutral about y
Jane loves hamburgers and dislikes soft drinks. Neither likes nor dislikes soft
drinks
Since Jane can freely dispose of the soft drink if it is given to her, she considers it to
be a neutral good. This means she does not care about soft drinks one way or the
other. With hamburgers on the vertical axis, her indifference curves are horizontal
lines. Her satisfaction increases in the upward direction.  No matter the # of soft
drinks she gives up she will not gain a unit of hamburger
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