ECON 130 Lecture 4 12/3/15

(1) quality dominating

(2) characteristic of expenditure proportions
a. expenditure on good remains unchanged

Quality effect negates expenditure effect

Price increases, quantity decreases – not enough to counteract the total amount,
so overall expenditure goes up

Importance: indifference curve shapes

Sqr fn. Doesn’t really change as good 1 and good 2 change (red line)

# of utility matters – cardinal

If good 2 consumption increases, compensation of fall in good 2 will occur.

Indifference curves – asymptotes at axes; bounded away from axes

Red line –
Never compensated for consuming nothing
No amount of G2 will compensate for G1
If compensation of G1 falls below ½, no amount of G2 will compensate

Expected Utility
Utility fn. used to measure level of risk aversion to explain why you get a greater
return on held equities compared to government bonds.

Utility fns have been chosen to give nice utilities

Adding constant to utility fn does nothing because of differentiation

Higher utility means higher preference

Preferences are not restricted by income
Income constraint is introduced to reduce the feasible number of consumption
bundles

Will the marginal changes affect my marginal utility?