Topic 4 - Choice

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Published on 28 Sep 2011
School
UTSG
Department
Economics
Course
ECO206Y1
Professor
Topic 4 Choice
(Lecture 2 Sept 23rd)
Assume: x1,x2; p1,p2;
x2
x1
Math: Constrained Optimization
-- U(x1,x2); Max(x1,x2) s.t. p1x1+p2x2=Y
      
-- Solve: 3 first-order conditions;
1.
 
   
2.
 
    
3. 
      
-- Intuition:
MUx1 = 
 = ;
MUx2 = 
 =  

 left: MRS (internal marginal valuation)
right: OC (external marginal valuation)
Budget Constraint: x1p1 + x2p2 = Y
Intuition:
-- Points on the budget constraint represent choices
that fully exhaust individuals income;
-- Every bundle on the budget constraint is associated
with an indifference curve and defines a level of utility;
-- The individual has to choose the bundle on the
constraint that maximized the individuals utility;
-- The max is given by a tangency.
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Document Summary

Topic 4 choice (lecture 2 sept 23rd) - points on the budget constraint represent choices that fully exhaust individual"s income; - every bundle on the budget constraint is associated with an indifference curve and defines a level of utility; - the individual has to choose the bundle on the constraint that maximized the individual"s utility; - the max is given by a tangency. x1. - at point a, the slope of the indifferent curve is mrs; - at point a, the slope of the budget constraint is oc; - clearly at point a, mrs > oc; - msr>oc: how much x2 the individual is willing to give up for an additional unit of x1 (msr) is more than what they have to (oc). - move down the budget line until x2 x1. Problem: there are a lot of tangencies that satisfy this equation (a. k. a. Solution: foc 3 the tangency must lie on the budget line.