A primer on

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• A primer on
• Consumer Choice
• Finding the optimal choice

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Constrained consumer choice

• The consumer will want to choose the best bundle
  within her opportunity set
• Nothing lying beyond the budget constraint is
  reachable
• We can always find something better that what
  lies inside the budget constraint...

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Figure 4.08a Consumer Maximization
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Constrained consumer choice

• We want to choose a bundle that lies at the
  tangency of the budget constraint and the
  indifference curve

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MRS and MRT

• Marginal Rate of Substitution between pizzas and
  burritos
• telling us how many burritos we are willing to
  give up for an extra bit of pizza
• and the Marginal Rate of Transformation was the
  ratio of prices, the slope of the budget
  constraint

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Interior solution

• The MRS MRT between pizzas and burritos if we
  have an interior solution
• You will make yourself best-off when you choose
  your bundle by making equal your, subjective,
  relative valuation of the goods (MRS) and the,
  objective, relative valuation of the goods made
  in the market (MRT)

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Interior solution

• To understand this remember that we have
  decreasing MRS
• This means that the more pizzas we have relative
  to burritos, the less we value pizzas relative to
  burritos
• By sliding along our indifference curves or along
  our budget constraint we would be changing our
  MRS
• When are we going to stop?

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Interior solution

• Remember the ratio of prices is given (regardless
  of how much you slide along your indifference
  curves/budget constraint)
• Now imagine you are currently consuming a bundle
  that makes your MRS pizza-burrito very high
• What does it mean?
• Well it must mean that according to your own
  taste you have relative few pizzas if compared to
  burritos, that makes the MRS high you would be
  willing to give away many burritos for a slice of
  pizza!

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Interior solution

• So perhaps you are going to choose a bundle with
  more pizza and less burritos, right?
• Because you seem to have now too little pizza and
  too many burritos to be happy, right?

Go to hidden slide
Go to hidden slide
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Interior solution

• Probably but not for sure!!!
• If we feel we want more pizza we need to check
  first if WE CAN AFFORD IT
• We must compare our subjective valuation or pizza
  in relation to burritos with the objective
  valuation pizza-burrito the market exhibits
  through the ratio of prices!!!

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Interior solution

• Now we are getting at it
• So we had very little pizza gt our valuation of
  pizza relative to burritos is high
• Imagine is so high that it actually is much
  higher than most peoples, in any case it is
  higher than the relative price of pizza to
  burritos, than the ratio
• ...than the relative opportunity cost for society
  of making pizzas and burritos, than the MRT
  pizza-burrito

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Interior solution

• Then, as long as our personal MRS exceeds the
  objective MRT in the market, we are going to make
  ourselves better-off by choosing more pizza and
  less burritos
• We cannot improve once MRSMRT

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Corner solution

• But we can have a corner solution too
• This happens when we try to follow our rule of
  sliding until MRS MRT but we are stopped by one
  of the axes
• This is because we cannot consume less than 0
  pizza nor less than 0 burritos!!!

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Figure 4.08b Consumer Maximization
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An example

• Steven is indifferent between buying books
  on-line or in a shop they are the same price and
  quality
• But then the government taxes books in the shop

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Solved Problem 4.3
Initially ANY point on I2 will be the best for
him
After the tax, he will obviously choose to shop
only on-line!as suggested by the new budget
constraint L
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Concave preferences

• Do you remember when we would have concave
  preferences?
• What kind of optimal choice do you think they
  will result in?

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Figure 4.09a Optimal Bundles on Convex Sections
of Indifference Curves
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Figure 4.09b Optimal Bundles on Convex Sections
of Indifference Curves
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Next

• Deriving Demand Curves
• The price-consumption curve
• The income-consumption curve
• The Engel curve
• The effects of a price change