Transcript Ch21A-- Indifference Analysis

Appendix to Chapter 5
Indifference Analysis
Indifference Curves
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Indifference analysis is an alternative way
of explaining consumer choice that does
not require an explicit discussion of utility.
Indifferent: the consumer has no
preference among the choices.
Indifference curve: a curve showing all the
combinations of two goods (or classes of
goods) that the consumer is indifferent
among.
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Indifference Curve
All points along the
indifference curve
represent combinations
that are equally satisfying
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Indifference Curves: Shape
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A common shape for an indifference
curve is downward sloping.
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For the consumer to be indifferent to
the bundle of goods chosen, as less of
one good is consumed, more of another
must be consumed.
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Indifference Curves: Shape (2)
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The indifference curves are not likely to be
vertical, horizontal, or upward sloping.
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A vertical or horizontal indifference curve holds the
quantity of one of the goods constant, implying that the
consumer is indifferent to getting more of one good
without giving up any of the other good.
An upward-sloping curve would mean that the
consumer is indifferent between a combination of goods
that provides less of everything and another that
provides more of everything.
Rational consumers usually prefer more to less.
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Indifference Curve Shapes
Improbable or impossible shapes:
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Indifference Curves: Slope
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The slope or steepness of indifference
curves is determined by consumer
preferences.
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It reflects the amount of one good that a consumer
must give up to get an additional unit of the other good
while remaining equally satisfied.
This relationship changes according to diminishing
marginal utility—the more a consumer has of a good,
the less the consumer values an additional value of
that good. This is shown by an indifference curve that
bows in toward the origin.
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Marginal Rate of Substitution
The slope of an
indifference curve
represents the rate at which
a consumer would be
willing to exchange one
good for another – with
indifference
That ratio is called the
Marginal Rate of
Substitution
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Indifference Curves:
No Crossing Allowed!
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Indifference curves cannot cross.
If the curves crossed, it would mean that the
same bundle of goods would offer two different
levels of satisfaction at the same time.
If we allow that the consumer is indifferent to all
points on both curves, then the consumer must
not prefer more to less.
There is no way to sort this out. The consumer
could not do this and remain a rational consumer.
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Indifference
Curves Cannot
Cross!
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Indifference Map
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An indifference map is a complete set of
indifference curves.
It indicates the consumer’s preferences
among all combinations of goods and
services.
The farther from the origin the indifference
curve is, the more the combinations of
goods along that curve are preferred.
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Indifference
Map
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Budget Constraint
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The indifference map only reveals the
ordering of consumer preferences among
bundles of goods. It tells us what the
consumer is willing to buy.
It does not tell us what the consumer is
able to buy. It does not tell us anything
about the consumer’s buying power.
The budget line shows all the
combinations of goods that can be
purchased with a given level of income.
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The
Budget Line
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Consumer Equilibrium
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The indifference map in combination with the
budget line allows us to determine the one
combination of goods and services that the
consumer most wants and is able to
purchase. This is the consumer equilibrium.
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The demand curve for a good can be derived
from indifference curves and budget lines by
changing the price of one of the goods
(leaving everything else the same) and
finding the equilibrium points.
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Consumer
Equilibrium
The consumer maximizes satisfaction by
purchasing the
combination of
goods that is on the
indifference curve
farthest from the
origin but attainable
given the
consumer’s budget.
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Deriving the
Demand Curve
By changing the price of
one of the goods and
leaving everything else
the same, we can derive
the demand curve.
In (a), the price of a gallon
of gasoline doubles,
rotating the budget line
from Y1 to Y2. The
consumer equilibrium
moves from point C to E,
and the quantity
demanded of gasoline
falls from 3 to 2.
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