A primer on
Consumer Choice
Finding the optimal choice
Lecture 12
slide 1
Constrained consumer choice
The consumer will want to choose the best bundle
within her opportunity set
Nothing lying beyond the budget constraint is
reachable
We can always find something better that what lies
inside the budget constraint...
Lecture 12
slide 2
Figure 4.08a Consumer Maximization
Lecture 12
slide 3
Constrained consumer choice
We want to choose a bundle that lies at the
tangency of the budget constraint and the
indifference curve
Lecture 12
slide 4
MRS and MRT
Marginal Rate of Substitution between pizzas and burritos:
AB
AZ
MU Z
MRS =
=? B
MU
telling us how many burritos we are willing to give up for an
extra bit of pizza
and the Marginal Rate of Transformation was the ratio of
pZ
prices, the slope of the budget constraint
?pB
Lecture 12
slide 5
Interior solution
The MRS = MRT between pizzas and burritos if we have an
interior solution
You will make yourself best-off when you choose your
bundle by making equal your, subjective, relative valuation
of the goods (MRS) and the, objective, relative valuation
of the goods made in the market (MRT)
Lecture 12
slide 6
Interior solution
To understand this remember that we have decreasing MRS
This means that the more pizzas we have relative to burritos,
the less we value pizzas relative to burritos
By sliding along our indifference curves or along our budget
constraint we would be changing our MRS
When are we going to stop?
Lecture 12
slide 7
Interior solution
Remember the ratio of prices is given (regardless of how
much you slide along your indifference curves/budget
constraint)
Now imagine you are currently consuming a bundle that
makes your MRS pizza-burrito very high
What does it mean?
Well it must mean that according to your own taste you have
relative few pizzas if compared to burritos, that makes the
MRS high: you would be willing to give away many
burritos for a slice of pizza!
Lecture 12
slide 8
Interior solution
So perhaps you are going to choose a bundle with more pizza
and less burritos, right?
Because you seem to have now too little pizza and too many
burritos to be happy, right?
Go to hidden slide
Lecture 12
Go to hidden slide
slide 9
Corner solution
But we can have a corner solution too
This happens when we try to follow our rule of sliding until
MRS = MRT but we are stopped by one of the axes
This is because we cannot consume less than 0 pizza nor less
than 0 burritos!!!
Lecture 12
slide 13
Figure 4.08b Consumer Maximization
Lecture 12
slide 14
An example
Steven is indifferent between buying books on-line or in a
shop: they are the same price and quality
But then the government taxes books in the shop
Lecture 12
slide 15
Solved Problem 4.3
Initially ANY point on I2
will be the best for him
After the tax, he will obviously
choose to shop only on-line!…as
suggested by the new budget
constraint L*
Lecture 12
slide 16
Figure 4.09a Optimal Bundles on Convex Sections of Indifference
Curves
Lecture 12
slide 18
Figure 4.09b Optimal Bundles on Convex Sections of Indifference
Curves
Lecture 12
slide 19
Next
Deriving Demand Curves
The price-consumption curve
The income-consumption curve
The Engel curve
The effects of a price change
Lecture 12
slide 20