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Indifference Curve Analysis

Indifference curve analysis uses indifference curves to represent different bundles of two goods that provide the same level of utility for a consumer. Indifference curves have four key properties: 1) they are downward sloping, 2) they are convex, 3) their slope represents the marginal rate of substitution, and 4) higher indifference curves represent higher levels of utility. A consumer's budget constraint shows the combinations of goods that can be purchased given prices and income. At the point of utility maximization, the indifference curve will be tangent to the budget constraint where the marginal rate of substitution equals the price ratio.

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68 views

Indifference Curve Analysis

Indifference curve analysis uses indifference curves to represent different bundles of two goods that provide the same level of utility for a consumer. Indifference curves have four key properties: 1) they are downward sloping, 2) they are convex, 3) their slope represents the marginal rate of substitution, and 4) higher indifference curves represent higher levels of utility. A consumer's budget constraint shows the combinations of goods that can be purchased given prices and income. At the point of utility maximization, the indifference curve will be tangent to the budget constraint where the marginal rate of substitution equals the price ratio.

Uploaded by

AMIR ASIF
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Indifference curve analysis

Typical Consumption Bundles for Two Goods, X & Y


Indifference Curves
• Locus of points representing different bundles of
goods, each of which yields the same level of total
utility
• Properties:
1. All combinations of X and Y yield the same utility.
So the consumer is indifferent between A and B
combination of goods.
2. Indifference curves are downward sloping.
Negatively sloped . If more of good X is added,
some of good y must be taken away in order to
maintain the same level of utility.
Properties of Indifference curves
3. Indifference curves are convex ie as the consumer increases
consumption of good X, smaller amount of good Y is given up to stay at
the same level of utility. This is because of the law of diminishing
marginal utility.
The slope of the indifference curve measures the marginal rate of
substitution (MRS). Declines as we increase consumption of good X.

4
Indifference Curve are convex to the origin
Marginal Rate of Substitution
• MRS shows the rate at which one good can be
substituted for another while keeping utility
constant
• Negative of the slope of the indifference curve
• Diminishes along the indifference curve as X
increases & Y decreases
• Ratio of the marginal utilities of the goods

Y MU X
MRS   
X MUY
Slope of an Indifference Curve & the MRS

A
600

Quantity of good Y
T

320 C (360,320)

I
T’

B
0 360 800
Quantity of good X
4th property: Indifference Map

Quantity of Y
IV

III

II

Quantity of X
• An indifference curve on the right represents a bigger bundle of goods
and is preferred over the one on the left.

9
Marginal Utility
• Addition to total utility attributable to the addition of one unit of a
good to the current rate of consumption, holding constant the
amounts of all other goods consumed

MU  U X
Consumer’s Budget Line
• Shows all possible commodity bundles that can be
purchased at given prices with a fixed money income

M  PX X  PY Y
or
M PX
Y   X
PY PY
Consumer’s Budget Constraint
Typical Budget Line
M
PY •A

M PX
Y  X

Quantity of Y
PY PY

B
•
M
Quantity of X PX
Utility Maximization: Consumer equilibrium
• Utility maximization subject to a limited money
income occurs at the combination of goods for
which the indifference curve is just tangent to the
budget line

Y MU X PX
MRS    
X MUY PY
Utility Maximization
• Consumer allocates income so that the marginal
utility per dollar spent on each good is the same for
all commodities purchased

MU X MUY

PX PY
Constrained Utility Maximization

50
45 •A
Quantity of pizzas
40 •B • D

E IV
30
R
•
III
20
C
15 • II
T
10
I

0 10 20 30 40 50 60 70 80 90 100

Quantity of burgers
DESIGNING NEW AUTOMOBILES (II)

Different preferences of consumer groups for automobiles can affect their


purchasing decisions. Following up on Example 3.1, we consider two groups of
consumers planning to buy new cars.

FIGURE 3.14
CONSUMER CHOICE OF AUTOMOBILE ATTRIBUTES
The consumers in (a) are willing to trade Given a budget constraint, they will choose
off a considerable amount of interior a car that emphasizes acceleration.
space for some additional acceleration. The opposite is true for consumers in (b).
DESIGNING NEW AUTOMOBILES (I)

Preferences for automobile attributes can be described by


indifference curves. Each curve shows the combination of
acceleration and interior space that give the same
satisfaction.

PREFERENCES FOR AUTOMOBILE ATTRIBUTES

Owners of Ford Mustang coupes (a) are The opposite is true for owners of
willing to give up considerable interior space Ford Explorers. They prefer interior
for additional acceleration. space to acceleration (b).
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