Beruflich Dokumente
Kultur Dokumente
Theory
Why study economics?
• MRS diminishes as we
move along the curve
from left to right,
resulting in inward
bending shape
Perfect Substitutes and Perfect Complements
• Perfect Substitutes:
Two goods for which
the marginal rate of
substitution is a
constant.
• Perfect complements:
Two goods for which
the MRS is zero or
infinite; the
indifference curves are
shaped as right
angles.
Budget constraints
• This is the second element of consumer choice theory
• Consumers face budget constraint due to their limited
incomes.
• Typical equation for a budget line is: 𝑃𝐹 . 𝐹 + 𝑃𝐶 . 𝐶 = 𝐼
Clothing
I/ 𝑃𝐶
𝑃𝐹 . 𝐹 + 𝑃𝐶 . 𝐶 = 𝐼
I/ 𝑃𝐹 Food
𝑃𝐹
• Slope of the budget line: −
𝑃𝐶
Effect of change in Income and Price on the
budget line
i.e. 𝑀𝑅𝑆𝐹,𝐶 = 𝑃𝐹 / 𝑃𝑐
Marginal utility and consumer choice
• Let us say 𝑈 = 𝑓 𝑥, 𝑦
𝜕𝑓 𝜕𝑓
• Then 𝑀𝑈𝑥 = and 𝑀𝑈𝑦 =
𝜕𝑥 𝜕𝑦
• Total derivative of 𝑈 is: 𝑑𝑈 = 𝑀𝑈𝑥 𝑑𝑥 + 𝑀𝑈𝑦 𝑑𝑦
𝑑𝑦 𝑀𝑈𝑥
• Therefore, on an indifference curve, = −
𝑑𝑥 𝑀𝑈𝑦
𝑀𝑈𝑥
• In other words, MRS = .
𝑀𝑈𝑦
• Then the optimality condition becomes:
𝑀𝑈𝑥 𝑀𝑈𝑦
=
𝑃𝑥 𝑃𝑦
Problem 1
Consider the utility function 𝑈 𝑥, 𝑦 = 𝑥 0.4 𝑦 0.6 (This
is called Cobb-Douglas utility function)
a) Is the assumption that more is better satisfied for
both goods?
b) Does the marginal utility of x diminish, remain
constant, or increase as the consumer buys more x?
c) What is 𝑀𝑅𝑆𝑥,𝑦 for this utility function?
Problem 2
The utility that an economic agent receives by
consuming food F and clothing C is given by U(F, C) =
FC + F.
Food costs $1 a unit, and clothing costs $2 a unit.
The agent’s income is $22.
Find the utility-maximizing choice of food and
clothing.
Thank you!