Indifference curves - PowerPoint Presentation

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Indifference curvesSlide2

Warm-up Question

What do dating and marriage have to do with economics?

Scarcity

Choice

Utility maximization Slide3

Economics and Marriage

A market is any mechanism or institution that brings buyers together with sellers

Economists model markets

95% of Americans marry,

so most of us become buyers and sellers of marital partners at some point

The marriage market is simply the mechanism that brings us together Slide4

Marriage and Economics

What can be gained from marriage?

Are these gains more or less certain than a salary?Slide5

Marriage and Economics

“The estimation of unknown qualities is central to the search for a spouse.”Slide6

Utility

Utility

The level of happiness or satisfaction that someone experiences from buying a good or service

Utility is represented on a graph in an

indifference curveSlide7

The Indifference Curve

The indifference curve is economists’ answer to the age-old question:

What makes buyers happy, and how can we measure that happiness?

An indifference curve is how economists explain preferences Slide8

Consumption Bundles

We call the objects of consumer choice “consumption bundles”

Individuals

derive satisfaction or utility by consuming bundles of productsSlide9

Consumption Bundles

A consumption bundle consists of multiple goods between which the consumer is indifferent

At each point on the curve, the consumer has no preference for one bundle over

anotherSlide10

The Indifference Curve…

An indifference curve represents all the different combinations of two goods that generate the same level of utilitySlide11

The Indifference Curve…

What does that mean in plain English?

Each point on an indifference curve represents a combination of goods

All points on one indifference curve give the person the exact same amount of happiness

An indifference curve is mainly

used to represent observable demand patterns for individual consumersSlide12

For example…Slide13
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Indifference Curves

Notice how indifference curves bow in towards the originSlide15
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The Bachelor & Indifference Curves

Markets can exist

anywhere

Although money may not be involved, almost everything has a priceSlide18

The Bachelor & Indifference Curves

“Marital searchers look to the

wealth of information

that is embodied in prices. Although marital searchers have imperfect information about themselves as well as their suitors,

they are the best assessors

of their own aspirations and potential, and they

use this knowledge to set standards

for courtship and marital offers. Searchers use these standards, or social prices,

to estimate unseen qualities

in potential suitors.”Slide19

Marriage and Economics

“The estimation of unknown qualities is central to the search for a spouse.”Slide20

Indifference Curves

Once again, notice how indifference curves

bow in

towards the origin

This is because most people do not like extremes

For example, most people would rather have some shirts and some hats than many shirts and no hats

The changing preference results in the traditional inward-curving indifference curves

The changing preference also illustrates the effects of diminishing returns Slide21

For example…

In this example, diminishing returns simply means that the first hat Jim gets makes him happier than the second hat, which makes him happier than the third, and so onSlide22

For example…

Jim’s marginal utility—the extra utility he gets with each hat—decreases with the number of hats he getsSlide23

For example…

After a while, Jim has had enough of hats—the extra ones don’t make him happier—and he’d rather get a shirt

In fact, he may even trade several hats for one shirtSlide24

How can you relate marginal utility to the Bachelor? Slide25

What about multiple indifference curves?

Different indifference curves represent different levels of utility

In general, more is better: the more goods you have, the happier you areSlide26

Other notes on indifference curves

Indifference curves can NEVER cross

Why?

How can you tell that the indifference curves we’ve looked are for normal goods?

Because more of either good increases utilitySlide27

Odd Situations with Indifference CurvesSlide28

Indifference Curves: Undesirable Goods

If one good is a normal good, and the other is an undesirable good, the curves will look like the image to the left

An increase in the number of CDs causes an increase in utility

But, an increase in the amount of Spam results in a decrease in utilitySlide29

Indifference Curves: Neutral Goods

What if the consumer doesn’t care about one of the goods?

CDs and expired baseball tickets

Increasing or decreasing the # of baseball tickets makes NO difference in the curve

Only changing the number of CDs shifts the curveSlide30

Indifference Curves: Complementary Goods

Demand for complementary goods is directly related

i.e. buying one good increases the probability you’ll buy the other good

Example: mittensSlide31

Indifference Curves: Substitutes

More is better, but you don’t care what combination of the two you get

If you had a ton of Pepsi, you would NOT be willing to trade 3 cans of Pepsi for 1 can of Coke

This ELIMINATES the inward bend of the curveSlide32

Undesirable, Neutral, or Substitute? Slide33

Final Thoughts

It’s impossible to know exactly what goes on inside a buyer’s head while they are making a decision

There are so many differences between consumption bundles, economists have to find ways to simplify all the differences

The indifference curve is much simpler than reality—it needs to be in order to even remotely understand it—

WHICH IS THE POINT OF ECONOMICS