july11

Outline for Friday, July 11

� Remember

� Homework due Monday

� Quiz

� Review from Thursday� Review from Thursday

� Modeling the consumer

Quiz 1

� Ends at 11:30� Read carefully

� Raise your hand if you have questions

� This is not the end of today’s class


� Remember


� Quiz



The A elasticity of B

� How B responds to A

� How responsive B is to A




� The % change in B caused by a 1% change in A





� For small changes…B

A

slope

1⋅





� For small changes…

� For large changes…

B

A

slope

1⋅

Β

Α

A

B⋅

∆

∆

Price elasticity

� More elastic � less affected by shifts in curve

less burdened by taxes

less gained from subsidies

Price elasticity




� The more elastic party can change Q more easily� The more elastic party can change Q more easily

Price elasticity





� Elasticities are higher…

� In the long run

Price elasticity






� In the long run

�When more substitutes are available (demand)

�When inputs can be used elsewhere (supply)

Price elasticity






� In the long run

�When more substitutes are available (demand)

�When inputs can be used elsewhere (supply)

� Further away from zero

Other elasticities

� Income elasticity of demand

ξ < 0 inferior

0 < ξ < 1 necessity

1 < ξ luxury

� Cross-price elasticity (of demand)

1 < ξ luxury

ε < 0 complement

ε > 0 substitute


� Remember


� Quiz



Modeling the consumer

� Old assumption: The consumer is rational – will do as he/she pleases



� New, more detailed assumption: The consumer will buy the best affordable bundlebuy the best affordable bundle




� Bundle – mix of goods and services that can be bought





� Affordable – income is finite, prices are positive






� Best – must be modeled in greater detail






� Best – must be modeled in greater detail

� Our assumptions should describe how consumers choose


� The consumer will buy the best affordable bundle


� What positive statements can we make about � What positive statements can we make about consumer choice?




� Our model will make positive statements like� Our model will make positive statements like

“If the consumer has income Y and prices are P,

then they will consume bundle X”







� The consumer model predicts what will be consumed







� The consumer model predicts what will be consumed

� Just like the market model predicts what will be traded

What isn’t in our model

How consumers choose

� Consider the set of all bundles – combinations of goods that the consumer can imagine consuming


� Consider the set of all bundles

� We’ll assume that…




� The consumer is decisive – between two bundles, they knowknow

� which is best or

� that they are indifferent




� The consumer is decisive – completeness





� The consumer is consistent –� The consumer is consistent –

� If bundle a is at least as good as b

� And b is at least as good as c

�Then a is at least as good as c





� The consumer is consistent – transitivity� The consumer is consistent – transitivity






� The consumer is insatiable –

� If bundle a has at least as much of every good as bundle b

�Then a is at least as good as b






� The consumer is insatiable – monotonicity or “more is better”






� The consumer is insatiable – monotonicity

� In other words, the consumer can put all the bundles in rank or in order








� The order a consumer chooses is called his/her ordinal preferences over bundles








� The order a consumer chooses is called his/her ordinal preferences over bundles

� We can represent it as an inequality


� If we assume that a consumer is decisive, consistent and insatiable, we can represent their tastes with ordinal preferences



� A lot of microeconomic theory can be done with this




� With one additional assumption – continuity – we get cardinal preferences




� With one additional assumption – continuity – we get cardinal preferences

� These assign a number to each bundle – its utility


� Cardinal preferences give us the utility of every bundle



� Our utility function retains our assumptions

� Completeness – U(a) exists for all bundles a� Completeness – U(a) exists for all bundles a




� Completeness� Completeness

� Transitivity – U(a) ≥ U(b) ≥ U(c) � U(a) ≥ U(c)





� Transitivity

�Monotonicity – U(a+b) ≥ U(a)





� Transitivity

�Monotonicity

� We can graph it by considering all bundles for which utility is at least U0 – the weakly better set





� Transitivity

�Monotonicity

� We can graph it by considering all bundles for which utility is at least U0 – the weakly better set

� The “edge” of this set is an indifference set – the equally good set



� We are graphing in the space of bundles




� Both axes are quantities, but of different goods� Both axes are quantities, but of different goods





� Prices are not important, only what the consumer wants






� The goods in our bundle are all the consumer can buy






� The goods in our bundle are all the consumer can buy

Good X Good Y

Xigua Yogurt

Pizza Burrito

Consumption Leisure

Food Everything else


� We earlier assumed monotonicity: at least as much is at least as good



� Strict monotonicity: more of everything is better




� Indifference sets are curves, not thick bands� Indifference sets are curves, not thick bands





� Indifference curves do not cross






� Indifference curves slope down

Figure 4.2 Impossible Indifference Curves

(a) Crossing (b) Upward Sloping

b

(c) Thick

© 2007 Pearson Addison-Wesley. All rights reserved.

4–58

Z, Pizzas per semester

I 1

I 0

a

be


I

a a

b


I







� Completeness tells us that every point lies on an indifference curve







� Completeness tells us that every point lies on an indifference curve

� So we have an indifference map – an elevation map over the space of all bundles

An indifference map

20

30

Un

its o

f g

oo

d Y

The further out the curve,

the higher the level of utility

0

10

0 10 20

Un

its o

f g

oo

d

Units of good X

I1I2

I3

I4

I5

An indifference curve shows

all combinations of X and Y

that give a particular level of

utility.


� Remember


� Quiz



july11

Business

ahow responsive b

elasticity of bhow b

a1 afor small changes

end of todays class