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READING & VIDEO OUTLINE

Intermediate Microeconomics – Dr. Sauer

Chapter 4: Consumer Choice 4.1 The Budget Constraint The budget constraint is the The budget line refers to General form of the budget line:

General form of the budget constraint:

y-intercept:

x-intercept:

slope:

A Change in Income and the Budget Line

A Change in Price and the Budget Line

Work through the LBD exercise 4.1 here:

[screencast]

Start with a general budget line.
y

x

4.2 Optimal Choice A consumer’s optimal choice is the choice of a basket that 1. 2. The formal way to express the consumer’s problem is:

Refer to Figure 4.4. Basket ______ is optimal. It is on the ________________________ indifference curve while still being ____________ or ___________ the budget line. Basket D is not optimal because _______________________________________________. Baskets C and E are not optimal because ________________________________________.

At point A, the budget line and indifference curve are tangent. The slope of the budget line is:

The slope of the indifference curve is:

The tangency condition says that:

An interior optimum is:

An alternate way of writing the tangency condition:

In other words, at the optimum the marginal utility per dollar spent on good x is equal to the marginal utility per dollar spent on good y.

Using the Tangency Condition to Understand When a Basket is Not Optimal Watch the screencast and fill in the notes here. [screencast]

Refer to Figure 4.4. The preferences in this figure take the form U = FC. Therefore: MUF = ___

MUC = ____

Consider basket B. The MRSF,C at B is calculated to be:

At basket B, the consumer is willing to give up _____ units of clothing to get _____ units of food.

The slope of the budget line is calculated to be:

At B, the indifference curve is ________________than the budget line. The consumer’s rate of substitution is ___________________ than the market’s rate of substitution. - willing to give up ________ clothing for 1 more food - required to give up ____________ clothing for 1 more food Since the consumer is willing to give up more than he needs to, basket B is not optimal. _________________________________________________________________ Finding an Optimal Consumption Basket Work through the LBD exercise 4.2 here: [screencast]

At the optimal bundle, the following must be true: 1. the optimal bundle lies ________________________________ 2. the indifference curve is _______________ to the budget line at the optimal bundle (interior optimum) 1. Write the equation for the budget line.

2. If the indifference curve and budget line are tangent, they have the same slope at that point.

3. We have 2 equations and 2 unknowns. Use them to solve for the optimal bundle of x and y.

Two Ways of Thinking About Optimality 1.

2.

The expenditure minimization problem is:

Corner Points A corner point refers to

Watch the screencast and fill in the notes here. Refer to Figure 4.7.

[screencast]

For a consumer with these particular preferences, the indifference curves will never be tangent to the budget line. - no interior optimum - _________________________ at bundle R - consume ____________

When the slope of the indifference curve is steeper than the slope of the budget line, the consumer is willing to give up more y for a unit of x than the market requires. If: Then: slope of indifference curve ____ slope of budget line consumer wants a bundle with ___________ and ____________

Corner solution on the y axis: If: slope of indifference curve < slope of budget line Then: consumer wants a bundle with less x and more y

Work through the LBD exercise 4.3 here: 1. Write the equation for the budget line.

[screencast]

2. Find the slope of the indifference curve and the slope of the budget line. Then set them equal.

3. We have 2 equations and 2 unknowns. Use them to solve for the optimal bundle food and clothing.

Since David would optimally consume a __________________ amount of clothing, we know we have a corner solution. Spend all the income on food and none on clothing. How much food can he afford?

David’s optimal bundle is ______ units of food and ________ units of clothing. At this optimal bundle, we should see that the slope of the indifference curve is greater than the slope of the budget line.

At this optimal bundle, we should see that marginal utility per dollar spent on food is greater than the marginal utility per dollar spent on clothing.

Work through the LBD exercise 4.4 here:

[screencast]

She is always willing to trade 1 scoop of chocolate for 2 scoops of vanilla. We can deduce Sara’s _______________________________. - chocolate is on the x-axis MRSC,V … rate she’s willing to give up ____ to get one more ____. Willing to give up 2 vanilla for 1 more chocolate. Her MRSC,V = (slope of _____)

Her indifference curves all have a slope of _____. _____________! Which means chocolate and vanilla ice cream are ________________ for Sara.

The price of a scoop of chocolate ice cream is 3 times as expensive as vanilla ice cream. We can deduce the ____________ rate of substitution (slope of ____) - chocolate is on the x-axis

slope of BL =

Both the budget line and indifference curve are straight lines. Slope of IC vs Slope of BL

The indifference curve is ___________than the budget line.
Vanilla

We have a ________________. Sara’s bundle will consist of _____ vanilla ice cream and ______ chocolate.

Chocolate

4.3 Consumer Choice with Composite Goods A composite good is We will work through the Applications in class.

4.4 Revealed Preference Revealed preference is an analysis that

Are Observed Choices Consistent With Utility Maximization?

We’ll be working through LBD 4.5 and 4.6 together in class.

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