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Budget Constraint, Indifference Curves, Utility Function|Views: 240|Likes: 4

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https://www.scribd.com/doc/51224684/Budget-Constraint-Indifference-Curves-Utility-Function

11/09/2014

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BUDGET CONSTRAINT

M = P1X1 + P2X2 + ... + PnXn In a 2-good case (most frequently encountered):

**M = P1X1 + P2X2 P2X2 = M ² P1X1 X2 = (M / P2) ² X1. (P1/P2)
**

(P1/P2) is the trade-off between the two goods in the market place. Intercepts are (M / P1) for good 1 and (M / P2) for good 2.

AXIOMS

AXIOMS OF RATIONAL CHOICE: I ² COMPLETENESS (A decision will ALWAYS be made). II ² RELFEXIVE (Any bundle is at least as good as itself) III ² TRANSITIVE (If A is weakly preferred to B and B to C, then A is weakly preferred to C; Indifference Curves can·t cross) IV ² MONOTONICITY (Any bundle Y which is identical to bundle X, but with at least one more of one good is strictly preferred to bundle X; rules out thick indifference curves) V ² CONTINUITY (If A > B, then any situation C which is close to A is also >B; allows for smooth indifference curves and analysis of small changes in incomes/prices)

**UTILITY FUNCTIONS + INDIFFERENCE CURVES
**

Utility Measures are NON-UNIQUE; they are based on ordinal rankings. This means that any monotonic (ORDER PRESERVING ²i.e., the derivative keeps the same sign) transformation is permissible. Utility Functions are written in the form: Utility = U(x,y) Indifference Curves are graphic representations of preference ordering. Along the curve are combinations of goods which the consumer is indifferent to. Due to Monotonicity, bundles above the curve are on a HIGHER utility level, bundles below are on a LOWER one.

**INDIFFERENCE CURVES, MRS
**

Here, U·· > U· > U The MARGINAL RATE OF SUBSTITUTION is the rate of substitution of X and Y in order to keep U constant. Calculated by taking the differential of the Indifference curve, see next page. Because of convexity, MRS decreases as X increases. Homothetic Preferences manifest themselves in functions where there MRS depends on RATIOS of two goods.

Y

U·· U· U X

**DERIVING THE MRS
**

**Take the differential of the Indifference Curve:
**

U ! ( x, y )

xU xU dU ! dx dy xx xy xU xU dU ! 0, 3 U , dx dy ! 0 xx xy xU dy ! MRS ! xx xU dx xy

dy MU x ! MRS ! dx U MU y

**FOUR UTILITY FUNCTIONS
**

I ² COBB-DOUGLAS

U ( x, y ) ! x y

E

F

II ² PERFECT SUBSTIUTES

( x, y ) ! Ex F y

III ² PERFECT COMPLEMENTS

( x, y ) ! min(Ex, Fy )

x y U ( x, y ) ! , H H

IV ² CONSTANT ELASTICITY OF SUBSTIUTION (CES) [Most general form, I if d 0, II if d=1,H III if H d=- ]

?H e 1, H { 0A

Final Final Dissertation

Growing up as a mixed race liberal Muslim in a post-9/11 Western society.

Development Essay Final

Natural Resource Curse

International Environmental Agreements

Externalities

Moral Hazard

Adverse Selection

Labour Income Taxation

Capital Income Taxation

Voluntary Agreements

Environmental Kuznets Curves

New Institutional Economics

Financial Development

Choice Under Uncertainty

Growth Theories

Aggregation Roys Identity

The Utility Maximisation Problem

Commodity Taxation

Dependency Theory

Environmental Taxation

Production

Imperfect Competition

Risk and Uncertainty

Intertemporal Choice, Time Allocation

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Demand Functions, Elasticities, Slutsky

Inflation and Price Indices

Constrained Optimisation, Indirect Utility, Expenditure Function

Production

Compensating Variation, Equivalent Variation, Consumer Surplus, Revealed Preference

Imperfect Competition

Risk and Uncertainty

Intertemporal Choice, Time Allocation

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