utility and indifference analysis

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Utility and Utility and Indifference curve Indifference curve analysis analysis By. Nischay. K. Upamannyu By. Nischay. K. Upamannyu

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Page 1: Utility and Indifference Analysis

Utility and Utility and Indifference curve Indifference curve

analysisanalysis

By. Nischay. K. UpamannyuBy. Nischay. K. Upamannyu

Page 2: Utility and Indifference Analysis

Definition of UtilityDefinition of Utility

Definition:Definition:

According To Javones “Utility refer to abstract quality According To Javones “Utility refer to abstract quality whereby an object serves our purpose”.whereby an object serves our purpose”.

According To Hidden “Utility is that quantity of good to According To Hidden “Utility is that quantity of good to stisfy a want”.stisfy a want”.

According To Robinson “Utility is the quality in According To Robinson “Utility is the quality in commodities that makes individual want to buy them”. commodities that makes individual want to buy them”.

Page 3: Utility and Indifference Analysis

Meaning of UtilityMeaning of Utility

The term utility in economic is used to denote that The term utility in economic is used to denote that quality in a commodity or service by virtue of which quality in a commodity or service by virtue of which our want are satisfied. In other word, want and our want are satisfied. In other word, want and satisfying power of good is called utility.satisfying power of good is called utility.

“ “It is power of commodity which satisfy need and want It is power of commodity which satisfy need and want of the customer”.of the customer”.

Page 4: Utility and Indifference Analysis

Feature of UtilityFeature of Utility

Utility is subjective:- As it deal with the mental satisfaction Utility is subjective:- As it deal with the mental satisfaction of human being. A good and service may have different of human being. A good and service may have different utility to different person.utility to different person.

Exp-Liquor has utility for alcoholic not for others.Exp-Liquor has utility for alcoholic not for others.

Utility is Relative;- As a utility of a commodity never Utility is Relative;- As a utility of a commodity never remain the same. It vary with time and place.remain the same. It vary with time and place.

Exp- Cooler has utility in summer not during winter season.Exp- Cooler has utility in summer not during winter season.

Utility is not essentially useful:- A commodity having Utility is not essentially useful:- A commodity having utility need not to be useful.utility need not to be useful.

Exp- Liquor and cigarettes are not useful but if these things Exp- Liquor and cigarettes are not useful but if these things satisfy the want of addict so Liquor and cigarettes have satisfy the want of addict so Liquor and cigarettes have utility.utility.

Page 5: Utility and Indifference Analysis

Utility is independent of morality:- it has nothing to do Utility is independent of morality:- it has nothing to do morality. Use of liquor may not be proper form moral morality. Use of liquor may not be proper form moral point of view, but as these thing, satisfy the point of view, but as these thing, satisfy the intoxicants need and want.intoxicants need and want.

Page 6: Utility and Indifference Analysis

Type of UtilityType of Utility

Initial Utility:- The utility is derived from the first unit of Initial Utility:- The utility is derived from the first unit of commodity is called initial utility. It is obtained from commodity is called initial utility. It is obtained from the consumption of the first unit of a commodity. It is the consumption of the first unit of a commodity. It is always positive.always positive.

Total Utility:- The aggregate of utility obtained from the Total Utility:- The aggregate of utility obtained from the consumption of different unit of a commodity, is called consumption of different unit of a commodity, is called total utility.total utility.

Marginal Utility:- The changes that take place in the total Marginal Utility:- The changes that take place in the total utility by the consumption of an additional unit of utility by the consumption of an additional unit of commodity is called marginal utility.commodity is called marginal utility.

Page 7: Utility and Indifference Analysis

Type of marginal utilityType of marginal utility

Positive marginal utility:- if by consuming additional units Positive marginal utility:- if by consuming additional units of commodity, total utility goes on increasing than of commodity, total utility goes on increasing than marginal utility of these units will be positive. exp- Liquormarginal utility of these units will be positive. exp- Liquor

Zero Marginal utility:- If the consumption of additional Zero Marginal utility:- If the consumption of additional unit of commodity does not impact in the total utility. It unit of commodity does not impact in the total utility. It means the marginal utility of additional unit is zero. Exp- means the marginal utility of additional unit is zero. Exp- additional right shoes have zero marginal utility without additional right shoes have zero marginal utility without more left shoes.more left shoes.

Negative Utility:- If the consumption of an additional unit Negative Utility:- If the consumption of an additional unit of a commodity cause fall in total utility. It means the of a commodity cause fall in total utility. It means the marginal utility is negative.marginal utility is negative.

Page 8: Utility and Indifference Analysis

Table :- Show total utility, marginal utilityTable :- Show total utility, marginal utility

QuantityQuantity Total UtilityTotal Utility Marginal Marginal utilityutility

DescriptionDescription

00 00 8-0 =88-0 =8 Initial utilityInitial utility

11 88 14-8 =614-8 =6

Positive Positive utilityutility

22 1414 18-14 =418-14 =4

33 1818 20-18 =220-18 =2

44 2020 20-20 =020-20 =0 Zero UtilityZero Utility

55 2020 18-20 =-218-20 =-2 Negative Negative utilityutility

66 1818

Page 9: Utility and Indifference Analysis

Measurement of utilityMeasurement of utility: a quantification of : a quantification of satisfaction of wants and needs achieved satisfaction of wants and needs achieved through the consumption of goods and through the consumption of goods and servicesservices

There are two method for measuring utilityThere are two method for measuring utility Cardinal utilityCardinal utility:-cardinal utility, which is based on :-cardinal utility, which is based on

numerical value (1,2,3,4,5……).when utility is numerical value (1,2,3,4,5……).when utility is measured on the basis of cardinal utility so it is measured on the basis of cardinal utility so it is checked that what amount of money a consumer is checked that what amount of money a consumer is willing to pay for a good and service.willing to pay for a good and service.

Ordinal UtilityOrdinal Utility:-Ordinal utility, which is based on raking :-Ordinal utility, which is based on raking (firs, second, third, fourth, five ………). In this method utility (firs, second, third, fourth, five ………). In this method utility is expressed in utils.is expressed in utils.

Page 10: Utility and Indifference Analysis

Criticism on the measurement of utilityCriticism on the measurement of utility

It has been criticized by Prof. Simuelson as the value It has been criticized by Prof. Simuelson as the value of money because money keep changing therefore of money because money keep changing therefore utility can not be measured definitely in the terms of utility can not be measured definitely in the terms of money.money.

Page 11: Utility and Indifference Analysis

Law of Diminishing marginal utilityLaw of Diminishing marginal utility

Law of diminishing marginal utility is the foundation Law of diminishing marginal utility is the foundation stone of utility analysis. stone of utility analysis. Law of diminishing Law of diminishing marginal utility stated that as the quantity marginal utility stated that as the quantity consumed of a commodity increases, the utility consumed of a commodity increases, the utility derived form each successive unit decrease and derived form each successive unit decrease and this law applies to all kind of consumer goods-this law applies to all kind of consumer goods-Durable and non-durable- sooner and later.Durable and non-durable- sooner and later.

Exp- if some one buy a pen so the utility of pen will be Exp- if some one buy a pen so the utility of pen will be highest but as he keep on buying pen and increase highest but as he keep on buying pen and increase the no. of pen so the utility of the pen would the no. of pen so the utility of the pen would automatically be reduced. It apply also real life of automatically be reduced. It apply also real life of human being.human being.

Page 12: Utility and Indifference Analysis

Table of Total and Marginal utility Table of Total and Marginal utility SchedulesSchedules

No. of unit No. of unit consumedconsumed

Total UtilityTotal Utility Marginal Marginal UtilityUtility

11

22

33

44

55

66

3030

5050

6060

6565

6060

4545

3030

2020

1010

55

-5-5

-15-15

Page 13: Utility and Indifference Analysis

Graph PresentationGraph Presentation

70

60

50

40

30

20

10

0

-10

1 2 3 4 5 6 7

TU

MU

Page 14: Utility and Indifference Analysis

Why Does the MU DecreaseWhy Does the MU Decrease??

The utility gained form a unit of a commodity The utility gained form a unit of a commodity depend on the intensity of the desire for it. When depend on the intensity of the desire for it. When a person consume successive unit of commodity, a person consume successive unit of commodity, his need is satisfied by degree in the process of his need is satisfied by degree in the process of consumption, and the intensity of his need goes consumption, and the intensity of his need goes on decreasing therfore the utility obtained from on decreasing therfore the utility obtained from each successive unit goes on decreasing.each successive unit goes on decreasing.

Page 15: Utility and Indifference Analysis

Definition:-Definition:-

According to Marshall “the additional benefit which a According to Marshall “the additional benefit which a person derives form given stock of thing diminishes person derives form given stock of thing diminishes with every increases in the stock that he already has”.with every increases in the stock that he already has”.

According to Champion “the more we have thing, the According to Champion “the more we have thing, the less we want additional increments of it or more we less we want additional increments of it or more we want not to have additional increment of it.”want not to have additional increment of it.”

According to Samuelson “as the amount consumed of According to Samuelson “as the amount consumed of good increase the marginal utility of a good tends to good increase the marginal utility of a good tends to decrease”.decrease”.

it is clear from the above definition that at a given it is clear from the above definition that at a given time when we go on consuming additional unit of a time when we go on consuming additional unit of a commodity, the marginal utility from each successive commodity, the marginal utility from each successive unit of that commodity, other thing being equal, goes unit of that commodity, other thing being equal, goes on diminishing in relation to the preceding unit.on diminishing in relation to the preceding unit.

Page 16: Utility and Indifference Analysis

Assumption of Law of Diminishing marginal Assumption of Law of Diminishing marginal utilityutility

The unit of the consumer good must be a The unit of the consumer good must be a standard, one Exp- a cup of tea, bottled of cold standard, one Exp- a cup of tea, bottled of cold drink, a pair of shoes or trousers, etc. it the units drink, a pair of shoes or trousers, etc. it the units are excessively small or large, the law may not be are excessively small or large, the law may not be applied.applied.

Consumer taste or preference must be remain the Consumer taste or preference must be remain the same during the period of consumption otherwise same during the period of consumption otherwise law of diminshing marginal utility may not be law of diminshing marginal utility may not be applied.applied.

Page 17: Utility and Indifference Analysis

There must be continuity in consumption. Where There must be continuity in consumption. Where break in continuity is necessary, the time interval break in continuity is necessary, the time interval between the consumption of two units must be between the consumption of two units must be appropriately short.appropriately short.

Mental condition of the consumer must remain Mental condition of the consumer must remain normal during the period of consumption. normal during the period of consumption.

Page 18: Utility and Indifference Analysis

Explanation- Explanation- the law can be explained with the the law can be explained with the help of the table and figure below.help of the table and figure below.

UNITUNIT Total UtilityTotal Utility Marginal Marginal utilityutility

11 GlassGlass 2020 2020

22 GlassGlass 3232 1212

33 GlassGlass 4040 88

4 4 Glass Glass 4242 22

55 GlassGlass 4242 00

66 GlassGlass 3939 -3-3

Page 19: Utility and Indifference Analysis

50

40

30

20

10

0

-5

1 2 3 4 5 6

TU

MU

Page 20: Utility and Indifference Analysis

ExceptionException

Curious and Rare thing- Law does not apply to rare or Curious and Rare thing- Law does not apply to rare or curious thing like person who collect old and rare curious thing like person who collect old and rare coins, postage stamps as increasing managerial utility coins, postage stamps as increasing managerial utility as the stock of these rare article goes an increasing. as the stock of these rare article goes an increasing. They are alawys keen to obtain more & more unit of They are alawys keen to obtain more & more unit of such thing.such thing.

Misers- It seem law does not apply to misers who is Misers- It seem law does not apply to misers who is curious to acquire more and more wealth. Their desire curious to acquire more and more wealth. Their desire for money seem to be instablefor money seem to be instable

Page 21: Utility and Indifference Analysis

Good book or Poem :- It is said that by reading a good Good book or Poem :- It is said that by reading a good book or listening to melodious song and a beautiful book or listening to melodious song and a beautiful poem again and again on gets more utility than poem again and again on gets more utility than before.before.

Intoxicated thing- It is said that the desire of Intoxicated thing- It is said that the desire of intoxicated thing can not be end. The more use of intoxicated thing can not be end. The more use of such type of thing the more satisfaction is found.such type of thing the more satisfaction is found.

Initial unit- when the initial unit of a commodity is Initial unit- when the initial unit of a commodity is used in less than appropriate quantity, then the used in less than appropriate quantity, then the marginal utility from the additional units goes on marginal utility from the additional units goes on increasing.increasing.

Page 22: Utility and Indifference Analysis

Indifference CurveIndifference Curve

An indifference curve may be defined as the An indifference curve may be defined as the locus of locus of point each representing a different combination point each representing a different combination of two substitute goods, which yield the same of two substitute goods, which yield the same utility or level of satisfaction to the consumer.utility or level of satisfaction to the consumer. Therefore, he is indifferent between any two Therefore, he is indifferent between any two combination of two goods when it comes making a combination of two goods when it comes making a choice between them.choice between them.

An indifference curve is also An indifference curve is also called ISO Utility curve called ISO Utility curve and Equal utility curve.and Equal utility curve.

A consumer preference among consumption bundle A consumer preference among consumption bundle may illustrated with indifference curve (an indifference may illustrated with indifference curve (an indifference curve shows bundle of goods that the make consumer curve shows bundle of goods that the make consumer equally happy).equally happy).

Page 23: Utility and Indifference Analysis

Exp- a consumer consume two goods, X and Y, and he makes Exp- a consumer consume two goods, X and Y, and he makes five combination a, b, c, d and e of the two substitute five combination a, b, c, d and e of the two substitute commodities.commodities.

CombinationCombination Quantity of Quantity of Pepsi (Y)Pepsi (Y)

Quantity of Quantity of Pizza (x)Pizza (x)

Total Total UtilityUtility

AA

BB

CC

DD

EE

2525

1515

88

44

22

33

55

99

1717

3030

UU

UU

UU

UU

UU

Page 24: Utility and Indifference Analysis

Com

modit

y X

5 7 10 12 15 20 25 30 Commodity Y

30

25

15

10

0

Page 25: Utility and Indifference Analysis

The Marginal Rate of Substitution (MRS)The Marginal Rate of Substitution (MRS)

An indifference curve is formed by substituting one An indifference curve is formed by substituting one good for another. The MRS is the rate at which one good for another. The MRS is the rate at which one commodity can be substituted for another, the level of commodity can be substituted for another, the level of satisfaction remaining the same.satisfaction remaining the same.

Page 26: Utility and Indifference Analysis

Properties of Indifference curveProperties of Indifference curve

Indifference curve will be downward slopping.Indifference curve will be downward slopping.

Indifference curve can not intersect or touch each Indifference curve can not intersect or touch each other.other.

Indifference curve must be convex to the origin.Indifference curve must be convex to the origin.

Upper indifference curve represent a higher level of Upper indifference curve represent a higher level of satisfaction than the lower onessatisfaction than the lower ones

Page 27: Utility and Indifference Analysis

Indifference curve will be downward slopping :- Indifference curve will be downward slopping :- We We know that along and indifference curve the level of utility know that along and indifference curve the level of utility always same, this mean that to get the same level of utility always same, this mean that to get the same level of utility if the consumer consume more of one commodity , he has if the consumer consume more of one commodity , he has to consume less of the other commodity to maintain the to consume less of the other commodity to maintain the same level of utility. When the consumer increase the same level of utility. When the consumer increase the consumption of commodity q1, the consumption of the consumption of commodity q1, the consumption of the commodity q2 remaining the same, the utility level of the commodity q2 remaining the same, the utility level of the consumer will rise so to maintain the same level of utility consumer will rise so to maintain the same level of utility consumer has to sacrifice certain quantity of the consumer has to sacrifice certain quantity of the commodity q2 which will naturalize the additional gain in commodity q2 which will naturalize the additional gain in utility from q1.utility from q1.

Q2

A

B

0

C D Q1

Kk

P

R

U

Page 28: Utility and Indifference Analysis

Explanation :-Explanation :-

P is the a Point on the indifference curve U. P is the a Point on the indifference curve U. at this point the consumer consume OC unit at this point the consumer consume OC unit of commodity q1 and OA units of the of commodity q1 and OA units of the commodity q2. when the consumer moves commodity q2. when the consumer moves from the point of P to point R, he consume from the point of P to point R, he consume CD unit more of q1. as the result of this his CD unit more of q1. as the result of this his utility level increases. To neutralize this utility level increases. To neutralize this increase in utility he decrease consumption increase in utility he decrease consumption of q2 by the amount AB unit so as to remain of q2 by the amount AB unit so as to remain on the same indifference curveon the same indifference curve

Page 29: Utility and Indifference Analysis

Two indifference curves can not Two indifference curves can not intersect or touch each other:intersect or touch each other:

A

Q2

Q1

0 U0

U1C

DB

M N

Page 30: Utility and Indifference Analysis

Explanation:Explanation:

When two indifference curve intersect each When two indifference curve intersect each other. Suppose that there are two other. Suppose that there are two indifference Uo and U1, Where U1 denotes indifference Uo and U1, Where U1 denotes a higher level of utility than the indifference a higher level of utility than the indifference curve Uo. The curve intersect at a point A curve Uo. The curve intersect at a point A and C is a point of vertically above the point and C is a point of vertically above the point B. it can be said that CPB (C is more B. it can be said that CPB (C is more preferable than B), This means that an preferable than B), This means that an indifference curve has to lie wholly above or indifference curve has to lie wholly above or below another indifference curve so that a below another indifference curve so that a higher indifference curve represent a higher indifference curve represent a higher level of utilityhigher level of utility

Page 31: Utility and Indifference Analysis

An indifference curve must be convex An indifference curve must be convex to the origin:to the origin:

Indifference curve is not only negative sloped, Indifference curve is not only negative sloped, but are also convex to origin. The convexity of but are also convex to origin. The convexity of the indifference curves implies two properties.the indifference curves implies two properties.

1.1. that the two commodity are substitutes for each that the two commodity are substitutes for each otherother

2.2. That the marginal rate of substitution b/w the That the marginal rate of substitution b/w the two goods decreases as a consumer moves two goods decreases as a consumer moves along an indifference curve.along an indifference curve.

Page 32: Utility and Indifference Analysis

Upper indifference curve Represent a Upper indifference curve Represent a Higher level of satisfaction than the Higher level of satisfaction than the lower oneslower ones An indifference curve placed above and to An indifference curve placed above and to

the right of another represent a high level the right of another represent a high level satisfaction than the lower ones. It satisfaction than the lower ones. It represent a higher level of satisfaction. The represent a higher level of satisfaction. The reason is that upper indifference curve reason is that upper indifference curve contains all along its length a larger contains all along its length a larger quantity of one or both the good than the quantity of one or both the good than the lower indifference curve. And a larger lower indifference curve. And a larger quantity of a commodity is supposed to quantity of a commodity is supposed to yield a greater satisfaction than the smaller yield a greater satisfaction than the smaller quantity of it.quantity of it.

Page 33: Utility and Indifference Analysis

Comparison between Lower and Upper Comparison between Lower and Upper Indifference curveIndifference curve

Commodity Of X

COMMODITY

y

0 x

a

b

c

d

IC2

IC1

Page 34: Utility and Indifference Analysis

Consumer EquilibriumConsumer Equilibrium

consumer attains his equilibrium where he consumer attains his equilibrium where he maximizes his total utility, given his income maximizes his total utility, given his income and market prices of good and services and market prices of good and services what he consume.what he consume.

The consumer is said to be in Equilibrium when The consumer is said to be in Equilibrium when he obtains the maximum possible satisfaction he obtains the maximum possible satisfaction form his purchase, given the income of consumer form his purchase, given the income of consumer and prices of good in the market.and prices of good in the market.

Under the indifference curve and Budget line Under the indifference curve and Budget line approach consumer is in equilibrium at a point approach consumer is in equilibrium at a point where the price is touching the attainable point.where the price is touching the attainable point.

Page 35: Utility and Indifference Analysis

Consumer equalibirum of one goodsConsumer equalibirum of one goods

Consumer equilibrium

0x

mu1

mu

x

mu1

Page 36: Utility and Indifference Analysis

Equilibrium of the consumer of many Equilibrium of the consumer of many goodsgoods

A

Q

O

Q B

IC1

IC2

IC3

E

j

P m

K

Page 37: Utility and Indifference Analysis

Consumer EquilibriumConsumer Equilibrium

When consumer make choice about the When consumer make choice about the quantity of good and service to quantity of good and service to consume, it is presumed that their consume, it is presumed that their objective is to maximize total utility. In objective is to maximize total utility. In maximizing total utility, the consumer maximizing total utility, the consumer faces a number of constraints, the most faces a number of constraints, the most important of which are the consumer important of which are the consumer income and the prices of the goods and income and the prices of the goods and services that the consumer wishes to services that the consumer wishes to consume.consume.

Page 38: Utility and Indifference Analysis

Effect of change in income on consumer Effect of change in income on consumer demanddemand

We examine the effect of change in consumer’s We examine the effect of change in consumer’s income on his consumption behavior, assuming income on his consumption behavior, assuming that prices of all goods and services, and that prices of all goods and services, and consumer’s taste and preference remain constant.consumer’s taste and preference remain constant.

when consumer income change, his capacity to when consumer income change, his capacity to buy goods and services change too, other things buy goods and services change too, other things remaining the same. These changes are by a remaining the same. These changes are by a parallel upward or downward shift in the parallel upward or downward shift in the consumer’ budget line. When consumer income consumer’ budget line. When consumer income decrease, his budget line shift downward and decrease, his budget line shift downward and when consumer increase, his budget line shift when consumer increase, his budget line shift upward to the right. With the changes in his upward to the right. With the changes in his income, the consumer moves from one equilibrium income, the consumer moves from one equilibrium point to another. Such movement show the rise point to another. Such movement show the rise and fall in the consumption market.and fall in the consumption market.

Page 39: Utility and Indifference Analysis

A

B

C

D

E

J

J

K L M

IC1IC2

IC3IC4

IC5

C

I

N

Page 40: Utility and Indifference Analysis

Assumption of Consumer EquilibriumAssumption of Consumer Equilibrium

There must be indifference map showing scale of There must be indifference map showing scale of preference for various combination of good and this preference for various combination of good and this scale of preference remains the same throughout the scale of preference remains the same throughout the analysis.analysis.

Constant IncomeConstant Income Price remain constantPrice remain constant Good are divisibleGood are divisible

Page 41: Utility and Indifference Analysis

Budget Line or the Budget constrainBudget Line or the Budget constrain

Every rational consumer seek to maximise his Every rational consumer seek to maximise his total utility of the commodity bundle he consume. total utility of the commodity bundle he consume. However, he has a given income which sets limit However, he has a given income which sets limit to his maximizing behavior and it is called budget to his maximizing behavior and it is called budget line. When he spends it in purchasing particular line. When he spends it in purchasing particular proportions of the two commodities whose prices proportions of the two commodities whose prices are predetermined, income acts as constraints in are predetermined, income acts as constraints in the attempt for maximizing utility.the attempt for maximizing utility.

Exp- Let Y be the fixed income of the consumer Exp- Let Y be the fixed income of the consumer and P1 and P2 be the prices per unit of q1 and and P1 and P2 be the prices per unit of q1 and q2. then budget equation of the consumer can be q2. then budget equation of the consumer can be written as written as

Y=P1.Q1+P2.Q2Y=P1.Q1+P2.Q2

Page 42: Utility and Indifference Analysis

Graph of budget lineGraph of budget line

Q2

Q1

O

A

B

Y/P2

Y/P1

Page 43: Utility and Indifference Analysis

Income increaseIncome increase

If the income of the consumer increase, the price If the income of the consumer increase, the price of the commodity remaining the same, then his of the commodity remaining the same, then his budget line shift to the right. Similarly, if the budget line shift to the right. Similarly, if the income of the consumer decrease the budget line income of the consumer decrease the budget line will shift downward. will shift downward.

If the price of one commodity changes the price If the price of one commodity changes the price of the other commodity and the income of the of the other commodity and the income of the consumer remaining the same, the slope of the consumer remaining the same, the slope of the budget line change.budget line change.

Page 44: Utility and Indifference Analysis

Graph of budget line and its constraintsGraph of budget line and its constraints

Figure Figure . . 1- Budget line due to change in income, price 1- Budget line due to change in income, price remaining the same2- Budget line due to change in price of remaining the same2- Budget line due to change in price of q1, price of q2 and income remaining the same q1, price of q2 and income remaining the same

q2

0 q1

q2

0q1

C

A

E

F B D

A

D B C

Increase in income

Decrease in income

Decrease In price of good q1

Increase in price of good q1

Page 45: Utility and Indifference Analysis

The Budget LineThe Budget Line

Consumption Consumption possibilitypossibility

Ice cream (per Ice cream (per month)month)

Cola (Per Cola (Per month)month)

AA

BB

CC

DD

EE

FF

00

11

22

33

44

55

1010

88

66

44

22

00

Page 46: Utility and Indifference Analysis

The Budget lineThe Budget line

10

8

6

Cola

Per 4

Month

2

0

1 2 3 4 5 6 7 8 9 10

Ice Cream (per month)

Income Rs.30

Ice cream Rs. 5

Cola Rs. 3

unaffordable

affordable

Budget line

Page 47: Utility and Indifference Analysis

Changes in price and incomeChanges in price and income

10

8

6

4

2

0

1 2 3 4 5 6 7 8 9 10

10

8

6

4

2

0

1 2 3 4 5 6 7 8 9 10

Page 48: Utility and Indifference Analysis

Budget lineBudget line

Budget line and budget constraint line shows all the Budget line and budget constraint line shows all the possible combination of two goods that the consumer possible combination of two goods that the consumer can buy if he spend the whole of this given sum of can buy if he spend the whole of this given sum of money on his purchase at given prices.money on his purchase at given prices.

It represent the various combination of two goods It represent the various combination of two goods which can be purchased with a given money income which can be purchased with a given money income and assumed prices of good.and assumed prices of good.

Budget line is drawn as continuous line. It identifies Budget line is drawn as continuous line. It identifies the option from which the consumer cnn choose the the option from which the consumer cnn choose the combination of good.combination of good.

Page 49: Utility and Indifference Analysis

Budget line scheduleBudget line schedule

Suppose a consumer has Rs. 60 to spend on Apples and Suppose a consumer has Rs. 60 to spend on Apples and Mangoes and the prices of them are Rs. 6 and Rs. 12 per unit Mangoes and the prices of them are Rs. 6 and Rs. 12 per unit respectively. So its schedule can be as.respectively. So its schedule can be as.

CombinationCombination Apples (Rs.6)Apples (Rs.6) Mangoes (Rs.12)Mangoes (Rs.12)

AA 1010 00

BB 88 11

CC 66 22

DD 44 33

EE 22 44

GG 00 55

Page 50: Utility and Indifference Analysis

Change in the budget lineChange in the budget line

Income Changes:Income Changes: A change in the income, the prices of goods remaing A change in the income, the prices of goods remaing

the same, the budget line shift from original position to the same, the budget line shift from original position to the right upward or to the left inside.the right upward or to the left inside.

A rise in the income of a consumer shift the budget line A rise in the income of a consumer shift the budget line to the right or upwardto the right or upward

A fall in the income shift the budget line to the left side.A fall in the income shift the budget line to the left side.

Suppose the income of the consumer increases to Rs. 72 Suppose the income of the consumer increases to Rs. 72 so now it can buy 12 units of apples and 6 unit of so now it can buy 12 units of apples and 6 unit of mangoes. mangoes.

Page 51: Utility and Indifference Analysis

Change in the Budget lineChange in the Budget line

Price changesPrice changes

If the total income of money and price of one If the total income of money and price of one commodity remains the same and only price of one commodity remains the same and only price of one commodity changes so it also changes the budget commodity changes so it also changes the budget line.line.

It causes consumer to buy more of that commodity It causes consumer to buy more of that commodity which price has fallen.which price has fallen.

Suppose the price of mangoes has decrease form Rs 12 Suppose the price of mangoes has decrease form Rs 12 to Rs. 10 and income and price of apples remains to Rs. 10 and income and price of apples remains constant so now consumer can buy more of mangoes. constant so now consumer can buy more of mangoes.

Page 52: Utility and Indifference Analysis

Consumer SurplusConsumer Surplus

The concept of consumer surplus was first The concept of consumer surplus was first introduced by Marshall. The surplus arises introduced by Marshall. The surplus arises because we “receive more than we pay”. because we “receive more than we pay”. It It is difference between the amount of is difference between the amount of money that we are willing to pay and money that we are willing to pay and the money we actually paythe money we actually pay, consumer , consumer enjoy consume surplus if we pay the same enjoy consume surplus if we pay the same amount of money for each and every unit of amount of money for each and every unit of good bought. The amount that the consumer good bought. The amount that the consumer is willing to pay for the first unit of good he is willing to pay for the first unit of good he buys is termed as consumer marginal value. buys is termed as consumer marginal value. The marginal value decrease as more and The marginal value decrease as more and more units are bought . more units are bought .

Page 53: Utility and Indifference Analysis

Graph of Consumer SurplusGraph of Consumer Surplus

R1 r2

p1 p2

pN

B

O

A

Q1 Q2 Q q