Indifference curves Chapter 3 Budget line 2 Points on the budget line indicate all the bundles of goods that the consumer can afford Good 2 150 50 100 Good 1 150 100 0 50 Indifference Curve ID: 228346
Download Presentation The PPT/PDF document "Utilities" is the property of its rightful owner. Permission is granted to download and print the materials on this web site for personal, non-commercial use only, and to display it on your personal computer provided you do not modify the materials and that you retain all copyright notices contained in the materials. By downloading content from our website, you accept the terms of this agreement.
Slide1
UtilitiesIndifference curves
Chapter 3Slide2
Budget line
2
Points on the budget line indicate all the bundles of goods that the consumer can afford.
Good 2
150
50
100
Good 1
150
100
0
50Slide3
Indifference Curve
3
Indifference curve: locus of bundles that provide the consumer with the same level of satisfactionSlide4
Indifference curves
4
Good 1 (
x
1
)
0
10
Good 2 (
x
2)
20
100
140
w
b
a
Points on the same indifference curve represent bundles yielding the same amount of utility.Slide5
Indifference Curves
5
Indifference map
Set of indifference curves for a consumer
Every bundleOn an indifference curveIndifference curvesFarther from origin ->Higher utilitySlide6
The Shape of Indifference Curves
6
Indifference curves
Cannot slope upward
Nonsatiation assumptionCannot cross each otherTransitivity and nonsatiation assumptionsFarther from the origin – higher utilityNonsatiation assumptionCannot cross each otherAre bowed in toward the originConvexity assumptionFarther from the origin - higher utilitySlide7
Indifference curves cannot slope upward
7
Good 1 (
x
1
)
0
Good 2 (
x
2)
y
x
a
If an indifference curve ran from a to x, then bundle x would be no better than bundle a despite containing more of both goods. This upward slope of the indifference curve would be a violation of the nonsatiation assumption.
B
C
D
ESlide8
Indifference curves cannot cross each other
8
Good 1 (
x
1
)
0
Good 2 (
x
2)
I
1
I
2
c
b
a
If indifference curves I
1
and I
2
crossed at a, then by transitivity of preferences bundle b would be no better than bundle c despite containing more of both goods. This crossing of indifference curves would be a violation of the nonsatiation assumptionSlide9
Farther from the origin -> higher utility
9
Good 1 (
x
1
)
0
Good 2 (
x
2)
w
a
Bundle w must be preferred to bundle a because it contains more of both goodsSlide10
Bowed-in
10
Good 1 (
x
1
)
0
Good 2 (
x
2)
(a) Bowed-out indifference curves violate convexity of preferences. Bundle c is a weighted average of bundles a and b, but yields lower utility level because it is on an indifference curve that is closer to the origin.
(b) Bowed-in indifference curves satisfy the convexity of preferences. Bundle c, a weighted average of bundles a and b, yields a higher utility level
a
b
c
(a)
Good 1 (
x
1
)
0
Good 2 (
x
2
)
a
b
c
(b)Slide11
The Marginal Rate of Substitution
11
Marginal rate of substitution (MRS)
Particular point on indifference map
One consumerRatio of exchanging goodsSame utilityMRS = - ∆x2 / ∆x1 Slide12
The Marginal Rate of Substitution
12
Diminishing marginal rate of substitution
From convexity
Move along the indifference curveSame utility levelMRS decreasesSlide13
I
1
Convex preferences and the
MRS
13
As the consumer is given bundles containing more and more of good 2, she values an individual unit of good 2 less and less
a
d
c
Good 1 (
x
1
)
0
10
20
100
110
Good 2 (
x
2
)
10
9
60
100
b
-∆x
1
+∆x
2
+∆x
2
-∆x
1Slide14
Indifference Curves and Tastes
14
Flat indifference curves
Goods that yield no utility
Straight-line indifference curvesGoods that are perfect substitutesMRS - constant along an indifference curveIn a two-good worldIndifference curve - straight lineSlide15
15
Good 1 (
x
1
)
0
Good 2 (
x
2
)
(a) Flat indifference curves. The good measured on the horizontal axis is yielding no utility for the consumer.
(b) Straight-line indifference curves: perfect substitutes. The same amount of good 2 is always needed to compensate the consumer for the loss of one unit of good 1.
(a)
(b)
a
Good 1 (
x
1
)
0
3
8
11
Good 2 (
x
2
)
9
5
4
10
+∆x
2
-∆x
1
+∆x
2
-∆x
1Slide16
Indifference Curves and Tastes
16
Right-angle indifference curves
Goods that are perfect complements
Must be consumed in a fixed ratio to produce utilityIn a two-good worldRight angle indifference curvesBowed-out indifference curvesNonconvex preferencesSlide17
I
1
17
Good 1 (
x
1
)
0
Good 2 (
x
2)
(c) Right-angle indifference curves: perfect complements. Adding any amount of only one good to bundle a yields no additional utility.
(d) Bowed-out indifference curves: nonconvex preferences and the MRS. As the consumer is given bundles containing more and more of good 2, he values an individual unit of good 2 more and more.
(c)
(d)
Good 2 (
x
2)
10
11
-∆x
1
-∆x
1
Good 1 (
x
1
)
0
5
6
b
c
a
-∆x
1
b
a
+∆x
2
+∆x
2
+∆x
2Slide18
Perfect substitutes
18
Coke
0
Pepsi
Mary’s marginal rate of substitution is constant at any bundle of
Pepsi and Coke.Slide19
Optimal Consumption Bundle
19
Optimal consumption bundle
Maximize consumer’s utility
Within the economically feasible setBest bundleAccording to consumer’s preferencesCharacteristics of optimal bundlesIndifference curve tangent to budget lineSlope of indifference curve = MRS = -∆x2/∆x1Slope of budget line = price ratio = p1/p2MRS = p1/p2 Slide20
The optimal consumption bundle
20
At the optimal point e, the indifference curve is tangent to the boundary BB’ of the economically feasible consumption set.
Good 1 (
x
1
)
0
Good 2 (
x
2)
x
e
z
B
B’
F
+1
+1
-4
-3
m
n
k