Lecture 3

LECTURE 3
CONSUMPTION
Outline
1. Preferences.
2. Utility.
3. Budget Constraint.
4. Constrained Consumer Choice.

5. Behavioral Economics.
4-2
Premises of Consumer Behavior

Individual preferences determine the
amount of pleasure people derive from
the goods and services they consume.
Consumers face constraints or limits
on their choices.
Consumers maximize their well-being
or pleasure from consumption, subject
to the constraints they face.
4-3
Properties of Consumer Preferences

We start from a set of fundamental axioms,
that is assumptions assumed to be true about
consumer preferences that form the basis on
which we build the model of consumers
behaviour.
Completeness
Transitivity
Non-satiation
4-4

Completeness - when facing a choice
between any two bundles of goods, a
consumer can rank them so that one
and only one of the following
relationships is true: The consumer
prefers the first bundle to the second,
prefers the second to the first, or is
indifferent between them.
4-5

Transitivity - a consumers preferences
over bundles is consistent in the sense
that, if the consumer weakly prefers
Bundle z to Bundle y (likes z at least as
much as y) and weakly prefers Bundle y
to Bundle x, the consumer also weakly
prefers Bundle z to Bundle x.
4-6

More Is Better - all else being the
same, more of a commodity is better
than less of it (always wanting more is
known as nonsatiation).
Good - a commodity for which more is
preferred to less, at least at some levels of
consumption
Bad - something for which less is preferred
to more, such as pollution
4-7
Preference Maps
Indifference curve - the set of all
bundles of goods that a consumer views
as being equally desirable.
Indifference map - a complete set of
indifference curves that summarize a
consumers tastes or preferences
4-8
Figure 4.1 Bundles of Pizzas and

Burritos Lisa Might Consume
B, Bur ritos per semester
(a)
25
20
15
10
5
15
25
30
Z, Pizzas per semester
4-9

(a)
25
20
15
10
e
d
5
15
25
30
4-9

(a)
25
Which of these
two bundles
would be
preferred by
Lisa?
20
15
10
e
d
5
15
25
30
4-9

(a)
25
Which of these
two bundles
would be
preferred by
Lisa?
20
15
10
Lisa prefers
bundle e over
bundle d, since e
has more of both
goods: Pizza and
Burritos
e
d
5
15
25
30
4-9

(a)
25
Which of these
two bundles
would be
preferred by
Lisa?
20
15
Lisa prefers
bundle e over
bundle d, since e
has more of both
goods: Pizza and
Burritos
e
d
10
5
B
15
25
30
Lisa prefers
bundle e to any
bundle in area B
4-9

(a)
25
f
20
15
e
d
10
5
B
15
25
30
4-9

(a)
25
Which of these
two bundles
would be
preferred by
Lisa?
f
20
15
e
d
10
5
B
15
25
30
4-9

(a)
25
Which of these
two bundles
would be
preferred by
Lisa?
f
20
15
Lisa prefers
bundle f over
bundle e, since f
has more of both
goods: Pizza and
Burritos
e
d
10
5
B
15
25
30
4-9

(a)
25
Lisa prefers any

bundle in area A
over e
Which of these
two bundles
would be
preferred by
Lisa?
20
15
Lisa prefers
bundle f over
bundle e, since f
has more of both
goods: Pizza and
Burritos
e
d
10
5
B
15
25
30
4-9

(a)
A
25
f
20
15
e
d
10
5
B
15
25
30
4-9

(a)
A
25
20
15
e
a
d
10
5
B
15
25
30
4-9

(a)
A
25
20
15
e
a
d
10
5
B
15
25
30
If Lisa is indifferent
between bundles e, a,
and c ..
4-9

A
25
20
15
e
a
d
10
(b)
(a)
25
20
e
15
a
10
B
15
25
30
15
25
30
and c ..
4-9

A
25
20
15
e
a
d
10
(b)
(a)
25
20
e
15
a
I1
10
B
15
25
30
15
25
30
and c ..
4-9

A
25
20
15
e
a
d
10
(b)
(a)
25
20
e
15
a
I1
10
B
15
25
30
and c ..
15
25
30
we can draw an
indifferent curve over
those three points
4-9

(c)
A
25
20
15
e
a
d
10
(a)
25
20
e
15
a
I1
10
B
15
25
30
15
25
30
we can draw an
those three points
4-10

(c)
A
25
20
15
e
a
d
10
(a)
25
20
I2
15
a
I1
10
B
15
25
30
15
25
30
we can draw an
those three points
4-10

(c)
A
25
20
15
e
a
d
10
(a)
25
20
I2
15
a
10
I1
B
15
25
30
15
25
30
we can draw an
those three points
4-10

(c)
A
25
20
15
e
a
d
10
(a)
25
20
I2
15
a
10
I1
I0
B
15
25
30
15
25
30
we can draw an
those three points
4-10
Properties of Indifference Maps

1. Bundles on indifference curves farther
from the origin are preferred to those
on indifference curves closer to the
origin.
2. There is an indifference curve through
every possible bundle.
3. Indifference curves cannot cross.
4. Indifference curves slope downward.
4-11
Impossible Indifference Curves

B, Burr itos per semester
e
b
a
I1
I0
4-12

Lisa is indifferent
between e and a, and
also between e and
b
e
b
a
I1
I0
4-12

Lisa is indifferent
also between e and
b
e
b
a
I1
I0
so by transitivity she
should also be
indifferent between a
and b
4-12

Lisa is indifferent
also between e and
b
e
b
a
I1
I0
should also be
and b
but this is impossible,
since b must be
preferred to a given it
has more of both goods.
4-12

Lisa is indifferent
also between e and
b
e
b
a
I1
I0
should also be
and b
since b must be
4-12

Lisa is indifferent
also between e and
b
e
b
a
I1
I0
should also be
and b
since b must be
4-12
a
I
4-13
Lisa is indifferent
between b and a
since both points
are in the same
indifference curve
a
I
4-13
Lisa is indifferent
between b and a
since both points
are in the same
indifference curve
But this contradicts
the more is better
assumption. Can
you tell why?
a
I
4-13
Lisa is indifferent
between b and a
since both points
are in the same
indifference curve
But this contradicts
the more is better
assumption. Can
you tell why?
Yes, b has more of
both and hence it
should be preferred
over a.
a
I
4-13
Solved Problem 4.1

Can indifference curves be thick?
Answer:
Draw an indifference curve that is at least
two bundles thick, and show that a
preference property is violated
4-14
B , Burr itos per semester
Solved Problem 4.1

4-15
Solved Problem 4.1

Consumer is
indifferent between b
and a since both
points are in the same
indifference curve
b

4-15
Solved Problem 4.1

Consumer is
indifferent between b
and a since both
points are in the same
indifference curve
b
a
But this contradicts the

more is better
assumption since b
has more of both and
hence it should be
preferred over a.

4-15
Willingness to Substitute Between

Goods
marginal rate of substitution (MRS) - the
maximum amount of one good a consumer will
sacrifice to obtain one more unit of another
good.
B
MRS
Z
The slope of the indifference curve!
4-16
Convex indifference curve
3
2
I
0
4-17
3
2
I
0
4-17
3
2
I
0
4-17
3
2
I
0
4-17
3
2
I
0
4-17
From bundle a to bundle

b, Lisa
is willing to give up 3 Burritos in
exchange for 1 more Pizza
8
3
3
2
I
0
4-17
8
3
3
2
I
0
4-17
8
3
From bundle b to bundle c,

Lisa is willing to
give up 2
for 1
Burritos in exchange
more Pizza
1
-2
c
I
0
4-17
8
3
1
-2
I
0
4-17
8
3
1
-2
c
1
-1
d
1
From bundle c to bundle d,

Lisa is willing to
give up 1
for 1
Burritos in exchange
more Pizza
4-17

The MRS from bundle
a to bundle b is -3.
This is the same as the
slope of the indifference
curve between those
two points.
8
3
1
-2
1
-1
d
1
I
6
4-17

The MRS from bundle
a to bundle b is -3.
curve between those
two points.
8
3
1
-2
c
1
-1
From b to c,
d
1
I
6
MRS = -2.
curve between those
two points.
4-17
Concave indifference curve
7
2
1
3
I
0
4-18
Concave indifference curve

From bundle a to
bundle b, Lisa is
willing to give up 2
Pizzas for 1
Burrito.
7
2
Nevertheless, from
b to c she is willing
to give up 3 Pizzas
for 1 burrito.
This is very unlikely
1
3
1
I
6
Could you think

why?
4-18
Curvature of Indifference Curves

In general we can have both convex or
concave indifference curves.
But casual observation suggests that most
peoples indifference curves are convex.
This implies a diminishing marginal rate of
substitution (also knows as law of diminishing
marginal utility).
The marginal rate of substitution approaches zero
as we move down and to the right along an
indifference curve.
4-19
Law of diminishing marginal utility

The increase in utility from one additional unit
of a good is lower the larger is the total
available amount of that good.
Examples:
Food: the first forkful of pasta al pesto is heaven, the 10th
is very good, the 50th is ok, the 300th Im getting sick.
Chocolate?
Counter-examples:
Antibiotics
Pringles?
Sunbathing
4-20
Two extreme cases
Perfect substitutes - goods that a

consumer is completely indifferent as to
which to consume.
Perfect complements - goods that a
consumer is interested in consuming only
in fixed proportions
4-21
Perfect Substitutes
Coke, Cans per week
0
Pepsi, Cans per week
4-22
Perfect Substitutes
Coke, Cans per week
Bill views Coke and

Pepsi as perfect
substitutes: can you
tell how his
indifference curves
would look like?
0
4-22
Perfect Substitutes
Coke, Cans per week
Bill views Coke and

Pepsi as perfect
tell how his
indifference curves
would look like?
Straight, parallel lines
with an MRS (slope)
of 1.
Bill is willing to
exchange one can of
Coke for one can of
Pepsi.
0
4-22
Perfect Substitutes
Coke, Cans per week
Bill views Coke and

Pepsi as perfect
tell how his
indifference curves
would look like?
with an MRS (slope)
of 1.
Bill is willing to
exchange one can of
Coke for one can of
Pepsi.
1
I1
1
4-22
Coke, Cans per week
Perfect Substitutes
Bill views Coke and
Pepsi as perfect
tell how his
indifference curves
would look like?
2
1
I1
I2
2

with an MRS (slope)
of 1.
Bill is willing to
exchange one can of
Coke for one can of
Pepsi.
4-22
Coke, Cans per week
Perfect Substitutes
Bill views Coke and
Pepsi as perfect
tell how his
indifference curves
would look like?
4
3
2
1
I1
I2
I3
I4
2
3
4

with an MRS (slope)
of 1.
Bill is willing to
exchange one can of
Coke for one can of
Pepsi.
4-22
Perfect Complements
Ice cream, Scoops per week
0
Pie, Slices per week
4-23
Perfect Complements
If she has only one

piece of pie, she
gets as much
pleasure from it
and one scoop of
ice cream, a,
0
4-23
Perfect Complements
If she has only one
piece of pie, she
gets as much
pleasure from it
and one scoop of
ice cream, a,
a
1
4-23
Perfect Complements
If she has only one

piece of pie, she
gets as much
pleasure from it
and one scoop of
ice cream, a,
as from it and two
scoops, d,
1
4-23
Perfect Complements
If she has only one

piece of pie, she
gets as much
pleasure from it
and one scoop of
ice cream, a,
1
as from it and two

scoops, d,
or as from it and
three scoops, e.
4-23
Perfect Complements
If she has only one

piece of pie, she
gets as much
pleasure from it
and one scoop of
ice cream, a,
I1
1
as from it and two

scoops, d,
or as from it and
three scoops, e.
4-23
Perfect Complements
I2
I1
2
If she has only one

piece of pie, she
gets as much
pleasure from it
and one scoop of
ice cream, a,
as from it and two
scoops, d,
or as from it and
three scoops, e.
4-23
Perfect Complements
I3
I2
I1
2
3
If she has only one

piece of pie, she
gets as much
pleasure from it
and one scoop of
ice cream, a,
as from it and two
scoops, d,
or as from it and
three scoops, e.
4-23
Imperfect Substitutes
B, Burritos per semester
I
4-24
The standardshaped, convex

indifference curve
lies between these
two extreme
examples.
I
4-24
The standardshaped, convex

indifference curve
lies between these
two extreme
examples.
Convex indifference
curves show that a
consumer views
two goods as
imperfect
substitutes.
4-24
Application: Indifference Curves

Between Food and Clothing
4-25
Utility
Ordinal utility function: from the completeness
axiom we know that we can rank all possible
bundles of goods. We have an ordinal
measure of preferences. Only relative
comparisons can be made.
Cardinal utility function: we assign a numerical
value to each bundle. Absolute comparisons
can be made.
4-26
Utility
Utility - a set of numerical values that
reflect the relative rankings of various
bundles of goods.
utility function - the relationship
between utility values and every
possible bundle of goods.
U(B, Z)
4-27
Utility Function: Example
u BZ
Question: Can determine whether Lisa would be
happier if she had Bundle x with 9 burritos and 16
pizzas or Bundle y with 13 of each?
Answer: The utility she gets from x is 12utils. The
utility she gets from y is 13utils. Therefore, she
prefers y to x.U= BZ.
4-28
Utility Function: 3D plot
4-29
Utility Function: 3D plot
4-30
Marginal utility
marginal utility - the extra utility that a
consumer gets from consuming the last unit of
a good.
the slope of the utility function as we hold the
quantity of the other good constant.
Marginal Utility of good Z is:
U
MU Z
Z
4-31
Utility and
Marginal Utility
U, Utils
(a) Utility
350
Utility function, U (10, Z )
230
10
Z , Pizzas per semester
4-32
Utility and
Marginal Utility
U, Utils
(a) Utility
350
250
230
10
4-32
Utility and
Marginal Utility
As Lisa consumes
more pizza, holding
her consumption of
burritos constant at
10, her total utility, U,
increases
U, Utils
(a) Utility
350
250
230
10
4-32
Utility and
Marginal Utility
As Lisa consumes
more pizza, holding
her consumption of
increases
U, Utils
(a) Utility
350
250
230
U = 20
Z = 1
10
4-32
Utility and
Marginal Utility
As Lisa consumes
more pizza, holding
her consumption of
increases
U, Utils
(a) Utility
350
250
230
U = 20
MU Z
Z = 1
U
Z
10
4-32
Utility and
Marginal Utility
As Lisa consumes
more pizza, holding
her consumption of
increases
and her marginal
utility of pizza, MUZ,
decreases (though it
remains positive).
U, Utils
(a) Utility
350
250
230
U = 20
MU Z
Z = 1
U
Z
10
4-32
Utility and
Marginal Utility
As Lisa consumes
more pizza, holding
her consumption of
increases
and her marginal
remains positive).
U, Utils
(a) Utility
350
250
230
U = 20
MU Z
Z = 1
U
Z
10
4-32
Utility and
Marginal Utility
U, Utils
(a) Utility
U = 20
MU Z
Z = 1
U
Z
10
(b) Marginal Utility

MU Z, Marginal utility of pizza
250
230
As Lisa consumes
more pizza, holding
her consumption of
increases
and her marginal
remains positive).
350
130
MU Z
0
10
4-32
Utility and
Marginal Utility
U, Utils
(a) Utility
U = 20
MU Z
Z = 1
U
Z
10

250
230
As Lisa consumes
more pizza, holding
her consumption of
increases
and her marginal
remains positive).
350
130
20
0
MU Z
1
10
4-32
Utility and
Marginal Utility
U, Utils
(a) Utility
U = 20
MU Z
Z = 1
U
Z
10

Marginal utility is the

slope of the utility
function as we hold
the quantity of the
other good constant.
250
230
As Lisa consumes
more pizza, holding
her consumption of
increases
and her marginal
remains positive).
350
130
20
0
MU Z
1
10
4-32
Utility and
Marginal Utility
U, Utils
(a) Utility
U = 20
MU Z
Z = 1
U
Z
10

Marginal utility is the

slope of the utility
function as we hold
the quantity of the
other good constant.
250
230
As Lisa consumes
more pizza, holding
her consumption of
increases
and her marginal
remains positive).
350
130
20
0
MU Z
1
10
4-32
Utility and Marginal Rates of

Substitution
4-33

Substitution
The MRS is the negative of the ratio of the
marginal utility of another pizza to the
marginal utility of another burrito.
4-33

Substitution
The MRS is the negative of the ratio of the
marginal utility of another pizza to the
marginal utility of another burrito.
Formally,
B
MU Z
MRS
Z
MU B
4-33
Budget Constraint
4-34
Budget Constraint
budget line (or budget constraint) - the
bundles of goods that can be bought if
the entire budget is spent on those
goods at given prices.
4-34
Budget Constraint
budget line (or budget constraint) - the
bundles of goods that can be bought if
the entire budget is spent on those
goods at given prices.
opportunity set - all the bundles a
consumer can buy, including all the
bundles inside the budget constraint and
on the budget constraint
4-34
Budget Constraint
4-35
Budget Constraint
If Lisa spends all her budget, Y, on pizza and
burritos, then
4-35
Budget Constraint
burritos, then
pBB + pZZ = Y
where pBB is the amount she spends on burritos
and pZZ is the amount she spends on pizzas.
4-35
Budget Constraint
burritos, then
pBB + pZZ = Y
where pBB is the amount she spends on burritos
and pZZ is the amount she spends on pizzas.
This equation is her budget constraint.

It shows that her expenditures on burritos and pizza use
up her entire budget.
4-35
Budget Constraint (cont).
4-36

How many burritos can Lisa buy?
To answer solve budget constraint for B (quantity of
burritos):
4-36

How many burritos can Lisa buy?
To answer solve budget constraint for B (quantity of
burritos):
PB B PZ Z Y
PB B Y PZ Z
Y PZ Z
B
PB
4-36

From previous slide we have:
Y PZ Z
B
PB
If pZ = $1, pB = $2, and Y = $50, then:
4-37

From previous slide we have:
Y PZ Z
B
PB
If pZ = $1, pB = $2, and Y = $50, then:
$50 ($1 Z )
B
25 0.5Z
$2
4-37
Budget Constraint
From previous slide we have
that if:
pZ = $1, pB = $2, and Y = $50,

then the budget constraint,
L1, is:
B
$50 ($1 Z )
25 0.5Z
$2
0
4-38
Budget Constraint
that if:
pZ = $1, pB = $2, and Y = $50,

L1, is:
B
$50 ($1 Z )
25 0.5Z
$2
L1
0
4-38
Budget Constraint

that if:
25 = Y/pB
pZ = $1, pB = $2, and Y = $50,

L1, is:
$50 ($1 Z )
25 0.5Z
$2
L1
0
4-38
Budget Constraint
25 = Y/pB
Amount of Burritos
consumed if all income
that if:
is allocated for
pZ = $1, pB = $2, and Y = $50,
Burritos.
L1, is:
B
$50 ($1 Z )
25 0.5Z
$2
L1
0
4-38
Budget Constraint
25 = Y/pB
Amount of Burritos
that if:
is allocated for
pZ = $1, pB = $2, and Y = $50,
Burritos.
L1, is:
B
$50 ($1 Z )
25 0.5Z
$2
L1
d
0
50 = Y /pZ
4-38
Budget Constraint
25 = Y/pB
Amount of Burritos
that if:
is allocated for
pZ = $1, pB = $2, and Y = $50,
Burritos.
L1, is:
B
L1
$50 ($1 Z )
25 0.5Z
$2
Amount of Pizza
is allocated for Pizza.
d
0
50 = Y /pZ
4-38
Budget Constraint
25 = Y/pB
20
Amount of Burritos
that if:
is allocated for
pZ = $1, pB = $2, and Y = $50,
Burritos.
L1, is:
B
b
L1
$50 ($1 Z )
25 0.5Z
$2
Amount of Pizza
d
0
10
50 = Y /pZ
4-38
Budget Constraint
25 = Y/pB
20
Amount of Burritos
that if:
is allocated for
pZ = $1, pB = $2, and Y = $50,
Burritos.
L1, is:
B
b
L1
10
$50 ($1 Z )
25 0.5Z
$2
Amount of Pizza
d
0
10
30
50 = Y /pZ
4-38
Budget Constraint
25 = Y/pB
20
Amount of Burritos
that if:
is allocated for
pZ = $1, pB = $2, and Y = $50,
Burritos.
L1, is:
B
b
L1
10
$50 ($1 Z )
25 0.5Z
$2
Amount of Pizza
Opportunity set
d
0
10
30
50 = Y /pZ
4-38
The Slope of the Budget Constraint

We have seen that the budget constraint for Lisa is
given by the following equation:
Y PZ
B Z
PB PB
4-39

Y PZ
B Z
PB PB
Slope = B/Z = MRT
4-39

Y PZ
B Z
PB PB
Slope = B/Z = MRT
The slope of the budget line is also called the marginal rate of
transformation (MRT)
rate at which Lisa can trade burritos for pizza in the marketplace
4-39
Allocations of a $50 Budget Between

Burritos and Pizza
4-40
Changes in the Budget Constraint: An

increase in the Price of Pizzas.
Slope = -$1/$2 = -0.5
B=
Y - PZ = $1
PB
PB
25
L1 (pZ = $1)
50
4-41

Slope = -$1/$2 = -0.5
25
L1 (pZ = $1)
$2
Y - PZ = $1
Z
PB
PB
B=
If the price of Pizza

doubles, (increases
from $1 to $2) the
slope of the budget
line increases
50
4-41

Slope = -$1/$2 = -0.5
25
L1 (pZ = $1)
$2
Y - PZ = $1
Z
PB
PB
B=

doubles, (increases
from $1 to $2) the
slope of the budget
line increases
L2 (pZ = $2)
0
25
50
4-41

Slope = -$1/$2 = -0.5
25
L1 (pZ = $1)
$2
Y - PZ = $1
Z
PB
PB
B=

doubles, (increases
from $1 to $2) the
slope of the budget
line increases
L2 (pZ = $2)
0
Slope = -$2/$2 = -1
25
50
4-41

Slope = -$1/$2 = -0.5
25
L1 (pZ = $1)
$2
Y - PZ = $1
Z
PB
PB
B=

doubles, (increases
from $1 to $2) the
slope of the budget
line increases
Loss
L2 (pZ = $2)
0
Slope = -$2/$2 = -1
25
50
4-41

Slope = -$1/$2 = -0.5
25
L1 (pZ = $1)
$2
Y - PZ = $1
Z
PB
PB
B=

doubles, (increases
from $1 to $2) the
slope of the budget
line increases
Loss
L2
(pZ = $2)
Slope = -$2/$2 = -1
This area represents

the bundles she can
no longer afford!!!
25
50
4-41
Changes in the Budget Constraint:

Increase in Income (Y)
B=
$50 PB
PZ
Z
PB
25
L1 (Y = $50)
0
50
4-42

$50 PB
B=
PZ
Z
PB
If Lisas income
increases by $50 the
budget line shifts to
the right (with the
same slope!)
25
L1 (Y = $50)
0
50
4-42

$100
$50
B= P B
PZ
Z
PB
If Lisas income
the right (with the
same slope!)
25
L1 (Y = $50)
0
50
4-42

$100
$50
B= P B
50
L3 (Y = $100)
25
PZ
Z
PB
If Lisas income
the right (with the
same slope!)
L1 (Y = $50)
0
50
100
4-42

$100
$50
B= P B
50
L3 (Y = $100)
25
PZ
Z
PB
If Lisas income
the right (with the
same slope!)
Gain
L1 (Y = $50)
0
50
100
4-42

$100
$50
B= P B
50
L3 (Y = $100)
25
If Lisas income
the right (with the
same slope!)
Gain
L1 (Y = $50)
0
PZ
Z
PB
This area represents

the new consumption
bundles she can now
afford!!!
50
100
4-42
Constrained optimization
Now we combine together the two tools we
introduced: indifference curve and budget
constraint (preferences and scarce
resources).
So, the consumer faces a constrained
maximization problem (maximize utility
subject to available income).
We will find the solution of the consumers
problem graphically, and show that the
solution can be of two types.
4-43
Consumer Maximization: Interior

Solution
25
20
10
I3
10
30
50
4-44

Solution
25
20
10
I3
10
30
50
4-44

Solution
25
20
10
I3
10
30
50
4-44

Solution
Would Lisa be able to

consume any bundle
I3 (i.e. bundle f)?
along
25
20
10
I3
10
30
50
4-44

Solution

consume any bundle
I3 (i.e. bundle f)?
along
No! Lisa does not have

enough income to afford
any bundle along I3
25
20
10
I3
10
30
50
4-44

Solution

consume any bundle
I3 (i.e. bundle f)?
along
No! Lisa does not have

enough income to afford
any bundle along I3
25
20
10
I3
I1
10
30
50
4-44

Solution
consume any bundle along

I1?
25
20
10
I3
I1
10
30
50
4-44

Solution

I1?
25
20
10
I3
d
10
a
30
I1
50
4-44

Solution

I1?
Yes; she could afford bundles

d, c, and a.
25
20
10
I3
d
10
a
30
I1
50
4-44

Solution

I1?

d, c, and a.
Nevertheless, there are other
affordable bundles that should
be preferred and affordable.
25
20
10
I3
d
10
a
30
I1
50
4-44

Solution

I1?

d, c, and a.
25
20
10
I3
d
10
a
30
I1
50
4-44

Solution

I1?

d, c, and a.
25
20
10
I3
d
For instance bundle e
10
a
30
I1
50
4-44

Solution

I1?

d, c, and a.
25
20
10
I3
d
10
a
30
I1
50
4-44

Solution

I1?

d, c, and a.
25
c
20
10

I3
A
0
10
a
30
I1
50
4-44

Solution

I1?

d, c, and a.
25
c
20
10
e
d
A
0
10

a
30
I3
I2
I1
50
4-44

Solution
Bundle e is called a
consumers optimum.
If Lisa is consuming this
bundle, she has no
incentive
to
change
her
behavior by substituting
one good for another.
25
c
20
10
e
d
A
0
10
30
I3
I2
I1
50
4-44

Solution
25
e
I2
0
50
4-45

Solution
The budget constraint and the indifference curve
have the same slope at the point e where they
touch.
Therefore, at point e:
25
e
I2
0
50
4-45

Solution
touch.
MU Z
PZ
MRS
MRT
MU B
PB
25
e
I2
0
50
4-45

Solution
touch.
MU Z
PZ
MRS
MRT
MU B
PB
25
Slope of I2
e
I2
0
50
4-45

Solution
touch.
MU Z
PZ
MRS
MRT
MU B
PB
25
Slope of I2
Slope of BL
e
I2
0
50
4-45
Consumer Maximization: Corner

Solution
25
I3
I2
Budget line
I1
50
4-46
Optimal Bundles on Convex Sections

of Indifference Curves
4-47
Solved Problem 4.4

Alexx doesnt care about where he lives, but
he does care about what he eats. Alexx
spends all his money on restaurant meals at
either American or French restaurants. His
firm offers to transfer him from its Miami office
to its Paris office, where he will face different
prices. The firm will pay him a salary in euros
such that he can buy the same bundle of
goods in Paris that he is currently buying in
Miami.11 Will Alexx benefit by moving to
Paris?
4-48
Solved Problem 4.4
4-49
Behavioral Economics
Recent field of economics that takes insights
from psychology and empirical research on
human cognition and emotional biases and
study their effect on individual choice, and
how it deviates from the rational model of
behaviour.
Examples: transitivity failure, endowment
effect, bounded rationality, rules of thumb.
4-50

Lecture 3

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LECTURE 3

4. Constrained Consumer Choice.

Premises of Consumer Behavior

Properties of Consumer Preferences

Properties of Consumer Preferences

Properties of Consumer Preferences

Properties of Consumer Preferences

Figure 4.1 Bundles of Pizzas and

Z, Pizzas per semester

Figure 4.1 Bundles of Pizzas and

Z, Pizzas per semester

Figure 4.1 Bundles of Pizzas and

Z, Pizzas per semester

Figure 4.1 Bundles of Pizzas and

Z, Pizzas per semester

Figure 4.1 Bundles of Pizzas and

Z, Pizzas per semester

Figure 4.1 Bundles of Pizzas and

Z, Pizzas per semester

Figure 4.1 Bundles of Pizzas and

Z, Pizzas per semester

Figure 4.1 Bundles of Pizzas and

Z, Pizzas per semester

Figure 4.1 Bundles of Pizzas and

Lisa prefers any

Z, Pizzas per semester

Figure 4.1 Bundles of Pizzas and

Z, Pizzas per semester

Figure 4.1 Bundles of Pizzas and

Z, Pizzas per semester

Figure 4.1 Bundles of Pizzas and

Z, Pizzas per semester

Figure 4.1 Bundles of Pizzas and

B, Bur ritos per semester

B, Bur ritos per semester

Z, Pizzas per semester

Z, Pizzas per semester

Figure 4.1 Bundles of Pizzas and

B, Bur ritos per semester

B, Bur ritos per semester

Z, Pizzas per semester

Z, Pizzas per semester

Figure 4.1 Bundles of Pizzas and

B, Bur ritos per semester

B, Bur ritos per semester

Z, Pizzas per semester

Z, Pizzas per semester

Figure 4.1 Bundles of Pizzas and

B, Bur ritos per semester

B, Bur ritos per semester

Z, Pizzas per semester

Z, Pizzas per semester

Figure 4.1 Bundles of Pizzas and

B, Bur ritos per semester

B, Bur ritos per semester

Z, Pizzas per semester

Z, Pizzas per semester

Figure 4.1 Bundles of Pizzas and

B, Bur ritos per semester

B, Bur ritos per semester

Z, Pizzas per semester

Z, Pizzas per semester

Figure 4.1 Bundles of Pizzas and