# Intermediate Microeconomics - PowerPoint PPT Presentation

PPT – Intermediate Microeconomics PowerPoint presentation | free to download - id: 72da82-N2QzY

The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
Title:

## Intermediate Microeconomics

Description:

### Intermediate Microeconomics Choice * – PowerPoint PPT presentation

Number of Views:81
Avg rating:3.0/5.0
Slides: 20
Provided by: Informat2158
Category:
Tags:
Transcript and Presenter's Notes

Title: Intermediate Microeconomics

1
Intermediate Microeconomics
• Choice

2
Optimal Choice
• We can now put together our theory of preferences
with our budget constraint apparatus and talk
• Unlike psychology, which often attempts to
understand why particular individuals make
particular choices, economic theory is trying to
develop a model of what individuals as a whole
generally do.
• Therefore, at its most basic, economic theory
simply assumes individuals choose their most
preferred bundle, or equivalently the bundle that
gives them the most utility, that is in their
budget set.

3
Optimal Choice
• Consider an individual with a 1000 and spends it
on lbs. of food and sq. ft. of housing, where pf
5/lb and ph 10/sq. ft.
• Budget Constraint depicted to the right. What are
intercepts? What is slope?
• If his preferences are captured by the
indifference curves depicted here, what will be
his optimal bundle? Why?

Lbs food
A
C
E
D
sq. ft.
B
4
Optimal Choice
• Why is A not optimal?
• Why is B not optimal?
• Why is C not optimal?
• Why is D not optimal?
• So what all is true at E?
• What happens if price of food falls?

food
A
C
E
D
sq. ft.
B
5
Optimal Choice
• Does tangency condition always have to hold for
optimum bundle?
• Consider goods that are perfect substitutes.
• e.g. Suppose you are working for Doctors without
Borders.
• You have 20 beds, malaria patients take a week to
treat, TB patients take two weeks. What does your
monthly budget constraint look like?
• Your preferences are such that you want to treat
as many patients as you can. What do your
indifference curves look like?
• So how would you optimally allocate your bed
slots per month?
• What if each Tuberculosis treatment cost took
only one week?

6
Optimal Choice
• Now consider two goods that are perfect
complements (i.e. must be consumed in fixed
proportions).
• E.g. I only like coffee if it is 1/2 coffee 1/2
milk.
• What will my indifference curves look like?
• Suppose I had 6, coffee costs 0.50/oz and cream
costs 1.00/oz.
• What will my budget constraint look like?
• What will be my optimal choice?
• What if prices were 1/oz for each?

7
Demand Function
• Demand Function for a given consumer for each
good i - the amount consumer chooses to consume
of that good given any set of prices and her
endowment
• qi(p1, p2, m)
• In general, demand function will tell how a
consumer reacts to changes in prices and
endowment.
• How would we derive a demand function
graphically?

8
Optimal Choice Analytically
• While graphs are informative, they can be
cumbersome, so we often want to solve things
analytically.
• For a two-good analysis, for each good i, we will
want to find a function qi(p1, p2, m) that maps
prices and endowment into an amount of that good.
• How do we find one of these? Where should we
start?

9
Optimal Choice Analytically
• Consider again an individual who finds q1 and q2
perfect substitutes, or
• U(q1,q2) q1 q2.
• So if he has 20 and p1 7 and p2 5, how much
• If he has 20 and p1 6 and p2 5, how much q1
• If he has 20 and p1 4 and p2 5, how much q1
• If he has 20 and p1 2 and p2 5, how much q1
• How would things change if he had 40?
• So what is general form of demand function for q1
and q2 given linear utility function?

10
Optimal Choice Analytically
• Demand functions for Quasi-linear utility
• U(q1,q2) aq10.5 q2,
• endowment m, prices p1 and p2
• Finding demand function is more complicated, but
still helps to think about graphically.
• What two conditions must be true at optimum
bundle given Quasi-linear utility?
• How can we use these conditions to find demand
functions?

11
Optimal Choice Analytically
• Demand functions for quasi-linear utility are
given by
• Do these demand functions make intuitive sense?
• What happens when p1 rises? Falls? How about a?
• What do these demand functions reveal about why
quasi-linear utility functions are not always
appropriate for modeling preferences?

12
Optimal Choice Analytically
• Now consider again an individual who has
Cobb-Douglas utility U(q1,q2) q1cq2d, who has
m, and faces prices p1 and p2.
• What two conditions must be true at optimum
bundle given Cobb-Douglas utility?
• How can we use these conditions to find demand
functions?

13
Optimal Choice Analytically
• So with Cobb-Douglas preferences, demand
functions will be given by
• Do these demand functions make intuitive sense?
• What happens when p1 rises? Falls?
• What happens when m rises?
• Why is it convenient to choose a specification
such that c d 1?

14
Optimal Choice Analytically
• Example
• Consider an individual whose preferences are
captured by U(q1,q2) q10.4q20.6
• p1 2, p2 4, m 20
• What is optimal bundle?
• How would we sketch this graphically?
• If p1 changed to 1, how would optimal bundle
change? How would graph change?

15
Application Government Funding of Religious
Institutions
• Suppose government is considering giving grants
to religious institutions with the restriction
that these funds are used for non-religious
purposes only.
• Why might advocates for separation of church and
state still find this proposal troubling?

16
Application Government Funding of Religious
Institutions
• Assume
• Govt grant equals 4,000/yr
• A religious institution has an annual budget of
20,000.
• Institutions preferences are captured by
U(qr,qn) qr0.75qn0.25
• What will be institutions spending on religious
and non-religious activity without grant?
• How will grant change budget constraint?
• What will be institutions spending on religious
and non-religious activity with grant?

17
Application Government Funding of Religious
Institutions
• What will this problem look like graphically?

18
Application Social Security Indexing for
Inflation
• This framework can help us think about issues
involved in indexing payments such as social
security.
• Adjustments in Social Security are currently
determined by changes in Consumer Price Index
(CPI). CPI is essentially determined by
calculating the price of a basket of goods.
• Some argue that this makes SS increasingly
generous over time and therefore should be
reformed. Why would they say this?

food
A
housing
19
Application Social Security Indexing for
Inflation
• Chained CPI recognizes consumers will change
optimal bundle as relative prices change.
• Idea is to keep utility the same.

food
A
housing