Calculate MRS
change in X2 / change in X1 = MU1/MU2 = P1/P2
Calculate elasticity of substitution
(% change in X2/X1) / % change in MRS
What does less curvature IC mean?
less curvature means greater %change in X2/X1 is required for MRS to change 1%, so higher elasticity
Define homothetic tastes
- a situation where consumer’s preference depend solely on the ratio of good 1 to good 2
- incomes rises, demand rises by the same proportion
Define quasilinear taste
- tastes are linear in 1 good, but may not in the other good
u(X1, X2) = vX1 + X2 - IC are vertical translation of each other
- constant MRS along any vertical line of x-axis
e.g. salt
Calculate PED
(diff X/PX)*(PX/X)
for demand function Qx = a-bPx
What is Hicksian demand?
- utility is the same after price changes
- ignore income effect
- how much demand changed solely based on price change
What is Slutsky demand?
- purchasing power is the same after price changes
- ignore income effect
- compensate consumer so still consume original bundle
- compensated BL passes through original bundle
Differences between Marshall, Hicksian and Slutsky demand
Marshall: consider both income and substitution effect (so giffen good has upward sloping demand curve)
H&S only has downward sloping demand curve, because only consider substitution effect
How to do the Lagrange method when optimising? （The Primal)
- set up the Lagrange
- find FOCs
- use FOCs to find MRS and set = price ratio
- Find an equation for the expansion path
- use BC and EP to find optimal bundle of goods.
How to do the Lagrange method when optimising? （The Dual problem)
- find initial bundle at original p ratio
- u max: consume on highest IC subject to BC - find change in D due to sub. effect
- expenditure min: less costly way - find the new bundle at new p ratio
- u max.
