Transcript Indifference Curve and Consumer Choice

Indifference Curve and
Consumer Choice
1
Overview
 Illustrated using example of choices on
movies and concerts
 Assumptions of preference
– ______________________
– ______________________
– ______________________
 Indifference curve
 Consumer choice
– maximize utility with constraint of budget
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Assumption 3: More is better
No. of
movies
per
month
D?
C?
B?
A
E?
No. of concerts per month
3
Assumption 3: Nonsatiation
-- More is better
No. of
movies
per
month
?
C
less
preferred
more preferred
B
A
?
B preferred to A
A preferred to C
No. of
concerts per
month
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Assumption 1: Can rank any two bundles
No. of
movies
per
month
B
A
‘More is better’ means
that as we go
northeast from C to B,
utility increases
C
No. of
concerts per
month
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Indifference Curve:
All Combinations of two Goods that yield the same level
of utility (Make the consumers equally well off.)
No. of
movies per
Month
B
D
A
C
After giving you an
additional concert, how
many movies could we
take away from you and
leave you no better or
worse off than D?
E
U0
No. of concerts per month
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Two things about the Indifference curve
 First, it slopes _____. This follows the
assumption about preferences
_________.
 Second, notice the curvature about the
indifference curve. As we move
downward and rightward along it, the
curve becomes _________. Why?
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Diminishing Marginal Utility:
As No. of concert increases, takes away decreasing
amounts of movies to leave utility unchanged
No. of
movies per
month
Along an indifference curve,
As No. of movies decreases and No.
of concerts increases, Marginal
utility from an additional movie
____ and Marginal utility from an
additional concert _______.
ΔM1
ΔM2
ΔM3
U0
ΔC
ΔC
ΔC
No. of concerts per month
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Marginal Rate of Substitution– the absolute value of the
slope of the indifference curve.
What does the slope (without the minus
sign) of indifference
Curve mean?
The maximum amount of movie Max
would willingly trade for one more
concert.
No. of
movies per
month
ΔM1
ΔM2
ΔM3
U0
ΔC
ΔC
ΔC
No. of concerts per month
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Marginal Rate of Substitution
Along the indifference curve,
the slope _______in absolute value;
the MRS _______ when No. of movies
decreases and No. of concert increases.
No. of
movies per
month
ΔM1
ΔM2
ΔM3
U0
ΔC
ΔC
ΔC
No. of concerts per month
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Indifference Map
-Ranking Indifference Curves
No. of
movies
per
month
Any point on
a higher
indifference
curve is
preferred to
anyUpoint on
1
a lower one.
B
A
C
U-1
U0
No. of concerts per month
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Budget Set: All combinations of goods that lie on
or inside the budget line
No. of
movies
per
month
15
Not affordable
affordable
5
No. of concerts per month
12
Combine budget line with indifference curve
No. of
movies
per
month
The optimal combination of
Goods for a consumer is the
Point on the budget line where
an indifference curve is tangent
to the budget line.
15
C
B
U2
U0 U1
A
5
No. of concerts per month
13
Combine budget line with indifference curve
No. of
movies
per
month
15
C
B
The absolute value of the slope of
the budget line=__________
The absolute value of the slope
of the indifference curve =______
The optimal decision-making rule
is _________________
U2
U0 U1
A
5
No. of concerts per month
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Changes in income
No. of
movies
per
month
30
A rise in income, with no change in
prices, leads to a new quantity
demanded for each good. Whether a
particular good is normal (quantity
demanded increases) or inferior
(quantity demanded decreases) depends
on the individual’s __________, as
represented by his ____________.
15
C
B
U2
U0 U1
A
5
10
No. of concerts per month
15
Changes in Price
No. of
movies
per
month
The drop in the price of
concert rotates Max’s
budget line ______.
Based on his difference
curves, he will choose
___. What if we dropped
the price of concert again?
15
B
C
U2
A
5
How can we derive
Max’s individual demand
curve for concert?
U0 U1
10
No. of concerts per month
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Income and Substitution Effects
 Demand curve actually summarizes impact of two
separate effects of price change on quantity demanded
 Substitution effects
– As the price of concert falls, its relative price ( relative
to movies) _____.
– Max substitutes concerts in place of movies whose
prices have not changed.
– It always moves quantity demanded in the opposite
direction to the price change
 When price decreases (increases), substitution
effect works to _______ (_______) quantity
demanded.
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The Income Effect
 When the price of concert drops, Max’s budget line
rotates rightward. The price decline of concert ____
his total purchasing power over both goods.
 Income effect can work to either increase or decrease
the quantity of a good demanded, depending on
whether the good is normal or inferior.
If concert is a normal good, the income effect of a
price cut will lead Max to consume _____ of them.
If concert is an inferior good, the income effect of
a price cut will lead Max to consume _______ of them.
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Figure 7: Combining Income and
Substitution Effects
Ultimate
Effect
(Almost Always)
Price Decrease:
P
Substitution Effect
Purchasing
Power
QD
QD
QD
if normal
if inferior
 QD
Price Increase:
P
Substitution Effect
Purchasing
Power
QD
QD
if normal
QD
if inferior
 QD
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