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Consumer choice 1. Budget set 2. Individual preference 3.

Purposive behavior Budget constraint: the set of consumption bundles that exactly exhausts the consumers income. The same object consumed in different states of nature are distinct goods. Rival: ones consumption detracts the ability for another to consume the same good Excludable: individual maybe be prevented from consuming a particular good. Private good: Excludable and rival Club good: excludable and non-rival Common goods: non-excludable and rival Public good: non-excludable and non-rival Numeraire: standard or basis making a new standalone variable, eliminates one variable and sets everything else as relative prices. Relative price: py/px= how many x for 1 y, px/py = how many y for 1 x D1/d2= -p1/p2 Opportunity cost: measure the value of a resource in its best alternative use. A change in income will keep the budget constraint parallel but shift it inward or outwards. A change in price will result in the budget constraint to swing from the good which had no price change X intercept= X max= m/px Y intercept= Y max = m/py

Utility function: function which will give a utility level Indifference curves: level sets of utility function. Bundles along this curve all have the same utility level. MRS: equal to relative price, slope of the indifference curve at a tangency point. Complete axiom: all possibilities can be considered Transitive: a>b, b>ca>c Monotone: more is better Equivalent bundles: bundles with the same level of utility

Indifference curves cannot cross Marginal utility: rate of change of utility changing the consumption of one good while holding the other good constant. (partial derivative of the utility function with respect to one of the goods) Marginal utility is always positive for a good. Negative for a bad Dy/dx= - Ux/Uy Marginal utilities are comparisons across indifference curves, MRS compares two bundles on the same indifference curve. Strict convexity: the averages are strictly preferred to the extremes Diminishing marginal utility: Uxx<0, reason why indifference curve isnt straight. Elasticity of substitution: the degree of responsiveness of the relative consumption of the two goods. Homotheticity: if a scalar multiple can ben applied to the function and answers stay consistent. Constant elasticity of substitution and homothetic: cobb douglas, perfect complements, perfect substitutes.

Utility maximization problem: keep income fixed, maximize utility. Max U(x,y) {x,y} L=U(x,y)- (pxx+pyy-m) Set both partial derivatives equal to lambda and equate the two. Plug into constraint to find marshallina demand functions. Indirect utility function: maximum amount of utility that a consumer can acquire. The Lagrange multiplier in a UMP corresponds to the consumers marginal utility of income Price of a good is proportional to the marginal utility(willingness to pay) px=Ux/ -Ux/Uy= -px/py marginal rate of substitution will equal relative price Optimal point: determined by the tangency between the budget constraint and the indifference curve. Expansion path: the path plotted connecting all the optimal points of multiple utility levels and budget constraints. s.t. pxx+pyy=m x,y> m

Marshallian demand function: exhausts the consumers income. Homogenous of degree 0 in prices and income Indirect utility function v(px,py,m)= U(x*,y*) 1. homogeneous degree 0 in prices and income 2. the partial derivative of the indirect utility function with respect to income equals lambda and is strictly positive. 3. The indirect utility function is non-increasing in px and py 4. Roys identity: marshallian demand: [dv(px,py,m)/dpx]/[dv(px,py,m)/m]. easier to calculate marshallian demand with indirect utility function

UMP: maximum utility possible with fixed income EMP: minimum expenditure possible with target utility Min . pxx+pyy {x,y} L= pxx+pyy (U(x,y)-U*) Hicksian demand: demand equations when a fixed utility is set Hicksian demand is homogenous of degree 0 Solution will result in no excess utility Expenditure function e(px,py,U*)= pxx*+pyy* 1. 2. 3. 4. Homogeneous of degree 1 in prices Function is increasing in U* Non decreasing in px and py concave px and py s.t. U(x,y)= U* x,y>0

: marginal expenditure of utility. Cost of additional utility Duality: allows one to know solutions to both problems after only doing one. E(px,py, U*= v(px,py,m))= m V(px,py,m=e(px,py,U*))=U* indirect utility from expenditure Expenditure function from the indirect utility function

Hicksian demand function= Marshallian demand function when U*=v(px,py,m) and m = e(px,py,U*) Xm(px,py,m=e(px,py,U*))= Xh(px,py,U*)

Xh(px,py,U*=v(px,py,m))= Xm(px,py,m) The two lagrange multipliers for UMP and EMP are inverses. Lambda= 1/ eta Own-price effect: the effect of a change in the price of a good on demand for that same good as an ownprice effect In general expect the hicksian own-price effect to differ from the marshallian own-price effect. Slutsky equation: decomposes the effect of a price change on marshallian demand into a substitution effect and an income effect. In hicksian demand fucntions the income effect is netted out Compensated demand functions: hicksian demand fucntions will have the consumer compensated in terms of consumption opportunities Uncompensated demand function: mashallian demand functions will have a non-positive own price effect if the good is a normal good Hicks compensation: keep s the original utility achievable after a price change. Minimal amount of income that will keep the original level of utility after price change. Cross price effects: measure the effect that variations in the price of a good have on demand for a different good. If + then substitutes, if then complements. When change in income is infinitesimal, the partial derivative of marshallian demand for good x with respect to income measures the ceteris paribus effect of income on demand for good x. Normal good: demand moves in the same direction as the change in income. Inferior goods: demand moves in the opposite direction as the change in income Feasibility condition rules out the case in which both goods are inferior. Change in demand is not synonymous with change in quantity demanded. Effect of a price change on marshallian demand will rely on a decomposition of the substitution effect and the income effect. Substitution effect: the change in the quantity demanded that arises solely from the change in price and not from the change in price and not from the change in consumption opportunities. Income effect: absent from hicksian demand, change on quantity demanded that arises solely from the change in income.

Slutsky compensation: compensating the consumer for a change in the price of a good to give him just enough income to keep his original utility maximizing consumption bundle just affordable after the price change. Considering infinitesimal price changes, the slutksy income effect converges to the hicksian income effect Net substitutes: price of good x increases, quantity of good x decreases but quantity of good y increases. Net complements: price of good x increases, quantity of good x decreases as well as quantity of good y. Compensated cross price effects are equal because cross partial derivatives is invariant to the order of differentiation. Gross substitutes: includes income effects, good y must increase in response to an increase in the price of good x. Gross complements: includes income effects, good y must decrease in response to an increase in the price of good x

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