indifference curve and

7/31/2019 Indifference Curve And

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INDIFFERENCE CURVE

ANDUTILITY ANALYSES


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INDIFFERENCE CURVEANALYSIS


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Consumers Preferences

A B C

5 Cokes 2Sprite

2 Cokes 6Sprites

4 Cokes 4Sprites

2nd Choice 1st Choice 2nd Choice

Assume Only Two Goods Sprite and Coke


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Assumptions

1. Individual can rank their preference:

B preferred to A and C. A and C indifferent.

2. Non Satiation:

Individuals are better off if they have more.

D = 5 cokes + 7 spritesD preferred to B

3. Transitivity:

If D is preferred to B

and B is preferred to A and C

then D is preferred to A and C

4. Individuals are willing to give up successively smalleramounts of onegood in order to get additional units of othergoods.


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How to Draw


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Key Concepts

Indifference Curves are downward sloping,

Convex and do not intersect,

Higher indifference curve reflects greater level

of satisfaction,

Slope is called Marginal Rate of Substitution

Convex curve means declining marginal rate of

substitution


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Declining Marginal Rate of

Substitution


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INDIFFERENCE CURVES

What is Preferred

Quantityo

fA

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12

Units ofA Price

$1.50

Units ofB Price

$1.00

Total

Expenditures

8 0 $126 3 124 6 12

2 9 120 12 12An Indifference

ScheduleCombi-

nation

Units

of A

Units

of B

j 12 2

j


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Quantityo

fA

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12

Units ofA Price

$1.50

Units ofB Price

$1.00

Total

Expenditures

8 0 $126 3 124 6 12


ScheduleCombi-

nation

Units

of A

Units

of B

j 12 2k 6 4

j

k

INDIFFERENCE CURVES

What is Preferred


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Quantityo

fA

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12

Units ofA Price

$1.50

Units ofB Price

$1.00

Total

Expenditures

8 0 $126 3 124 6 12


ScheduleCombi-

nation

Units

of A

Units

of B

j 12 2k 6 4l 4 6

j

k

l

INDIFFERENCE CURVES

What is Preferred


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Quantityo

fA

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12

Units ofA Price

$1.50

Units ofB Price

$1.00

Total

Expenditures

8 0 $126 3 124 6 12


ScheduleCombi-

nation

Units

of A

Units

of B

j 12 2k 6 4l 4 6

m 3 8

j

k

lm

INDIFFERENCE CURVES

What is Preferred


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Quantityo

fA

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12

Units ofA Price

$1.50

Units ofB Price

$1.00

Total

Expenditures

8 0 $126 3 124 6 12


ScheduleCombi-

nation

Units

of A

Units

of B

j 12 2k 6 4l 4 6

m 3 8

j

k

lm

I

INDIFFERENCE CURVES

What is Preferred
http://highered.mcgraw-hill.com/sites/0072819359/student_view0/chapter21/origin_of_the_idea.html


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I2

Quantityo

fA

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12

Units ofA Price

$1.50

Units ofB Price

$1.00

Total

Expenditures

8 0 $126 3 124 6 12


ScheduleCombi-

nation

Units

of A

Units

of B

j 12 2k 6 4l 4 6

m 3 8

j

k

lm

The sloperepresents

the marginalrate of substi-tution, (MRS)

I1

INDIFFERENCE CURVES

What is Preferred


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Quantityo

fA

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12

Units ofA Price

$1.50

Units ofB Price

$1.00

Total

Expenditures

8 0 $126 3 124 6 12


ScheduleCombi-

nation

Units

of A

Units

of B

j 12 2k 6 4l 4 6

m 3 8

I1

INDIFFERENCE CURVES

When Income Changes


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Quantityo

fA

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12

Units ofA Price

$1.50

Units ofB Price

$1.00

Total

Expenditures

8 0 $126 3 124 6 12


ScheduleCombi-

nation

Units

of A

Units

of B

j 12 2k 6 4l 4 6

m 3 8

I1

I2

I3

I4

INDIFFERENCE CURVES

A higher combination is Preferre


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Quantityo

fA

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12

Units ofA Price

$1.50

Units ofB Price

$1.00

Total

Expenditures

8 0 $126 3 124 6 12


ScheduleCombi-

nation

Units

of A

Units

of B

j 12 2k 6 4l 4 6

m 3 8

I1

I2

I3

I4

An

Indifference

Map

INDIFFERENCE CURVESA family of Curves is a Map


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THE BUDGET LINE:What is Attainable

Units ofA Price$1.50

Units of

B Price$1.00

TotalExpenditures

8 0 $126 3 12

4 6 122 9 120 12 12

Quantityof

A

Quantity of B

12

10

8

6

4

2

0 2 4 6 8 10 1


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Units ofA Price

$1.50

Units ofB Price

$1.00

Total

Expenditures

8 0 $126 3 124 6 122 9 12

0 12 12

(Attainable)Quantityo

fA

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12

(Unattainable)

THE BUDGET LINE:

What is Attainable


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Quantityo

fA

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12

Units ofA Price

$1.50

Units ofB Price

$1.00

Total

Expenditures

8 0 $126 3 124 6 12


ScheduleCombi-

nation

Units

of A

Units

of B

j 12 2k 6 4l 4 6

m 3 8

I1

I2

I3

I4

INDIFFERENCE CURVES

A higher combination is Preferre


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Key Concepts

The utility maximizing point occurs where thehighest indifference curve is tangent to thebudget constraint

At the utility-maximizing point, the rate thatproducts must be traded in the market is justequal to the rate at which the individual iswilling to substitute one good for the other.

P i Ch d Utilit M i i ti


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Quantityo

fA

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12

Units ofA Price

$1.50

Units ofB Price

$1.00

Total

Expenditures

8 0 $126 3 124 6 12


ScheduleCombi-

nation

Units

of A

Units

of B

j 12 2k 6 4l 4 6

m 3 8

I1

I2

I3

I4

Price Changes and Utility MaximizationA higher combination is Preferred

Ch i D d


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Quantityo

fA

Quantity of B

12

10

8

6

4

2

02 4 6 8 10 12

Units ofA Price

$1.50

Units ofB Price

$1.00

Total

Expenditures

8 0 $126 3 124 6 12


ScheduleCombi-

nation

Units

of A

Units

of B

j 12 2k 6 4l 4 6

m 3 8

I1

I2

I3

I4

Changes in Demand


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UTILITY THEORY


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Chapter 21 - Consumer Choice

24

Utility Theory

What is Utility

The want-satisfying power of a good or service

Utility Analysis

The analysis of consumer decision making based onutility maximization

Util

A representative unit by which utility is measured


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Assumptions of utility analysis

1. Cardinal Measurement: Satisfaction can bemeasured. Numbers can be assigned tomeasure satisfaction.

2. Independent: Utility of one commodity isindependent of other.

3. Constant Marginal Utility of Money: Marginalutility of money remains constant. More and

more money you get you will not be less andless satisfied.

4. From ones own experience it is possible to

guess satisfaction level of another person.


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26

Utility Theory

Marginal Utility

Definition: The change in total utility due to a one-unit change in the quantity of a good or service

consumed is called marginal utility.

Marginal utility = Change in total utilityChange in number of units consumed


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Some Maths

U = f(Q) dU/dQ = marginal utility

Suppose U = a + bQ + cQ2

How to maximize utility

du/dQ = b+2Q

And setting it to zero

b+2Q = 0

Q= -b/2 When Q is equal to -b/2 then it is maximum

Second derivative has to be negative


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28

Graphical Analysis

We can appreciate total and marginal utility byusing graphical analysis.


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29

Total and Marginal Utilityof Downloading and Listening to Digital

Music Albums

T t l d M i l Utilit


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30

Total and Marginal Utility

of Downloading and Listening to Digital

Music Albums

T l d M i l U ili


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Total and Marginal Utility

of Downloading and Listening to Digital

Music Albums


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32

Total and

Marginal Utility

of Downloadingand Listeningto Digital

Music Albums

Total utility ismaximized...

where marginalutility equals zero.


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33

Graphical Analysis

Observations

Marginal utility falls as more is consumed.

Marginal utility equals zero when total utility is atits maximum.


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34

Diminishing Marginal Utility

Diminishing Marginal Utility

The principle that as more of any good or serviceis consumed, its extra benefit declines

Increases in total utility from consumption of agood or service become smaller and smaller asmore is consumed during a given time period.

indifference curve and

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