Download Research Methods Applied to Sustainable Diversity

"Valuing Cultural Diversity in
Cities: Challenges to Cultural
Economics", Procida (Naples,
Italy), 5th of September 200
Foundations of Microeconomic
Theory
Laura Onofri
Department of Economics
University of Venice Cà Foscari
and FEEM
Introducing the Subject: Some
Challenging Questions
• Why do people study different languages?
• How do individuals choose the foreign language
they want to learn?
• Why should minority languages be protected?
• What is the value that individuals attach to the
preservation of a minority language?
• Can we define the price/value of a (minority)
language?
…….
Lecture Motivation and Content
• The present lesson aims at providing the
basic, non-technical notions about
economics reasoning, applied to standard,
neoclassical consumer’s theory.
• From preferences to utility functions to
demand functions to reservation price
Economics and Microeconomics
• Economics is the science that studies the
choices of rational agents (economic
agents, homo oeconomicus), in a world of
scarce resources.
• Microeconomics studies the choices of
three main economic agents: consumers,
firms and policy-makers.
• We want to explain,predict and evaluate
behavior and phenomena--not judge
The Two Dimensions of a Choice
(1)
• Consumers choose the optimal
consumption bundle by solving a
constrained maximization problem.
• The optimal choice is characterised by
both a psychological and a monetary
dimension.
The Two Dimensions of a Choice
(2)
• The psychological dimension is
represented by the notion of preferences
and utility functions, which map the
consumers tastes and desires.
• The monetary dimension is represented by
budget constraint (the income available for
purchasing goods).
Preferences
• Individuals’ tastes (preferences) determine
pleasure people derive from the
consumption of goods
• Economists usually take tastes as given
and do not judge taste
• Assumptions about consumer preferences
1. completeness
2. transitivity
3. more is better
Three main “axioms”
Completeness. Consumer can compare any
two bundles of goods and services and decide
which one is preferred or whether he (she) is
indifferent between them.
Transitivity (“rationality”). If a consumer prefers
bundle x over y and y over z, then x is preferred
over z.
More is better(aka non-satiation). A bundle with
more of one good and no less of others is
preferred.
Indifference Curves
we summarize information about an individual’s
preferences using a graph and we can rank some
bundles using more is better assumption
Indifference curve properties
1. bundles on indifference curves farther from the origin are
preferred to those on indifference curves closer to the
origin
2. there is an indifference curve through every possible
bundle
3. indifference curves cannot cross
4. indifference curves are “thin”
5. indifference curves slope down
Indifference Curves: Normal Goods
Marginal Rate of Substitution (1)
Willingness to substitute;
downward-sloping indifference curve:
consumer is willing to substitute one good
for the other
marginal rate of substitution (MRS) of x for y
is slope of indifference curve:
MRS = δx/δy
Marginal Rate of Substitution (2)
• MRS varies along the indifference curve
• When convex UF diminish marginal rates
of substitution (MRS)
Indifference Curves: Perfect Substitutes
and Perfect Complements
Indifference Curves: Perfect Substitutes
and Perfect Complements
• Perfect substitutes
straight line indifference curves
if slope is –1, MRS = 1 (Coke-Pepsi)
• Perfect complements
right-angle indifference curves
MRS = 0 (Coffee-Cream)
Marginal Rate of Substitution
Willingness to substitute;
downward-sloping indifference curve:
consumer is willing to substitute one good
for the other
marginal rate of substitution (MRS) of y for x
is slope of indifference curve:
MRS = δy/δx
Marginal Rate of Substitution
• MRS varies along the indifference curve
• When convex UF diminish marginal rates
of substitution (MRS)
Utility Functions
Numerical values that reflect relative
rankings of various bundles of goods
Relationship between utility measure and
every possible bundle of good
Succinct summary of information in
indifference map
Utility Functions
Utility and Marginal Utility
• Marginal utility of x: change in utility from a
small increase in x, holding y fixed.
MU = δU/δx
Budget Constraint
• Suppose an individual spends all her
income for purchasing goods y and x. Her
budget constraint is:
M = pxx + pyy
Rewrite as:
x = (M – pyy)/px
Budget Constraint: Opportunity Set
Marginal Rate of Transformation
• Slope of the Budget Constraint line:
py/px
• Opportunity set
all bundles a consumer can buy includes
bundles on and inside the budget
constraint
Consumers’Constrained Choice (1)
Consumers maximise the objective function
(utility function) subject to the budget
constraint
Max U(x,y)
s.t. M = pxx + pyy
The result of the maximization problem
provides the optimal bundle of goods x
and y that the consumer can purchase
within its possibility set.
Consumers’Constrained Choice (2)
• Optimal bundle, two possibilities
1. Interior solution: buy some units of all
goods (consumer buys some units of all
goods optimum bundle, e, where highest
indifference curve touches the budget
line)
2. Corner solution: buy only one good
Consumers’Constrained Choice:
Interior Solutions
Consumers’Constrained Choice:
Property of the Equilibrium Solution
At interior optimum, indifference curve is
tangent to budget line:
MRS = MRT
δy/δx = - py/px
• last Euro spent on x gives as much extra utility
as that spent on y
Individual Demand Curves
• The equilibrium solution indicates the
optimal amount of y and x that the
consumer can purchase within her
possibility set. It indicates a relationship
between quantity and (market) price of a
good:
Qx = f(px)
Qy = f(py)
Individual Demand Curves
Demand Functions
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p
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Demand Elasticity
Reservation Price
Willingness to Pay
Utility measured in monetary terms
Market Price
Market Values
References
• Varian, Hal., R. 1992. Microeconomic
Analysis 3rd Edition. W.W. Norton, New
York