Neoclassical Approach

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Neoclassical Approach

• Define the rational consumer.

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Why are we required to manage our resources?
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Market trade-off ability to buy orIncome
constraint

• Two goods world
• More of one good can be purchased if less of
  another is purchased
• Weigh up opportunity costs
• What do we mean by opportunity costs?

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Budget Constraint

• Depends on money budgeted and prices
• M Ps(Xs) Pc(Xc)
• Represents the maximum that can be spent on S and
  C given prices and income
• Money spent on S cannot be spent on C

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Budget Constraint
Two goods Steak 1.50 per serving Chicken
1.00 per serving
Possibilities Q Q
Steak Chicken
A 4 B 3 C 2 D 1 E 0 Using the information
provided, complete the chart and diagram the
budget constraint for steak and chicken.
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Budget Constraint
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Budget Constraint

• Consumers ability to trade or exchange units of
  goods depends on relative price
• Changes in the slope of the line are changes in
  the relative price
• Parallel changes in the slope are changes in
  income (relative prices constant)

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Personal Trade-off Willingness to Trade - -
Indifference Curve

• The consumers willingness to substitute one good
  for another
• Function of each consumers preferences
• Along any indifference curve, each combination of
  goods would make the consumer equally satisfied

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Indifference Curves
Indifference Combinations Steaks Chicken
A 1 6 B 2 3 C 3
2 D 4 1.5 E 7 1 Each
combination is equally satisfactory as any
other combination Plot combinations and draw the
indifference curve
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Maximization subject to constraints

• Combination of information on consumers
  preferences and the market constraint
• Graphically this happens at what point?

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Maximization subject to constraints
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Rational Decision

• Consumer will look out for his/her own best
  interest
• Assumptions
• perfection information
• certainty of preferences
• When we drop these assumptions what happens?

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Broader definition of consumption

• What constitutes consumption?
• U f(goods, services)
• Uf (commodities)
• What are we consuming?

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• Functional Demand
• part of demand from a commodity which results
  from a products inherent characteristics
• Nonfunctional Demand
• part of demand which results from factors other
  than characteristics inherent to a commodity