Chapter 3 The Behavior of Consumers - WSC_1_

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Chapter 3 The Behavior of Consumers - WSC_1_ Powered By Docstoc
					   Indifference curves

 Indifference curves represent a
summary of the consumer’s taste
   and preferences for various

There is no accounting for the taste of the consumer.
Consumers like what they like(various things influence
what they like - advertising, customs...). Consumers
derive utility or happiness by consuming goods and
services. In economics we summarize the likes or tastes
of the consumer by using indifference curves.

An indifference curve shows different combinations of
goods that give the same level of utility to the consumer.

                                Diagram used in analysis

          good y

The amount
of good y a
may have is
                                       good x
The amount of good x is measured on the horizontal
This type of diagram is used extensively when
considering the behavior of consumers.
                            Indifference curves - definition

   As mentioned earlier, an indifference curve
    shows various combinations of goods that
    yield some specific level of utility or
    satisfaction for the individual.
                           This is one type (and the
      A                    one we consider most,
                           initially) of
                           indifference curve. We
           B               assume the
                           individual is equally happy
                    x      at point A or B or any other
                           point on the indifference
                           curve.                      4
                           Indifference curves - feature 1

   We assume more goods are preferred to less
    and thus indifference curves slope downward
    to the right.
    y                          Say the individual is at
                               the point in the middle
          2      1             of the graph. Keep this
                               in mind as we explore
                               the following screens.
          3      4


                          Indifference curves - feature 1

 If the individual is at the point in the
  diagram, then all those points in area 1 and
  on the boundary are more preferred because
  those points have either more of both items or
  more of one and the same amount of the
  other item compared to the point chosen.
 Points in area 3 and the boundary are less
  preferred to the point in the diagram because
  the point chosen has more of both items.

                           Indifference curves - feature 1

 An individual may think that points in areas
  2 and 4 are preferable, less preferred or
  equally desirable to the point indicated.
 Since areas 2 and 4 are the only ones that
  could have a point of indifference to the one
  chosen, the indifference curves must have
  negative slope.

In economics we often use graphs and with graphs you can
look at the concept called slope. Often in economics the idea
of slope will have an economic interpretation. Let’s review
the idea of slope.
Slope = rise/run.
With a curve that slopes downward from left to right the slope
is a negative number.
With a curve that slopes upward from left to right the slope is
a positive number.

                Indifference curves - feature 2
                    Say the consumer is at
                    point A. If the
                    consumer gives up one
        B           unit of x, m units of y
m                   must be given back to
            A       hold the consumer at a
                    constant level of utility.

                x      You could say the
                    consumer is willing to
        1           trade 1 unit of x to get m
                    units of y.

                            Indifference curves - feature 2

 The shape of the indifference curve on the
  previous screen is said to be convex.
 Part of the reason for this is that it is assumed
  that the amount of good y one receives in
  return for one unit of x depends on how
  much of each the individual starts out with.

                                Indifference curves - feature 2
                           You can tell that point A has
                           less x than at B. As the
                           individual takes even one less
                           unit of x from either point A or
                      B    B, some y must be given in
                           But more is given in return if
                           point A is the initial point.
The point is the less you have of something(like x at
point A compared to point B), the more of other things
you must be given in return to compensate for the loss of
the one unit, assuming the same level of utility is
obtained.                                                11
                                     Indifference curves - feature 2
   The marginal rate of substitution(MRS) is the amount
    of y given in return for the one unit of x, while
    maintaining the same level of utility.
   We can think of the MRS as a fraction:
       MRS=absolute value of
           (change in y)/(change in x) .
   In this sense, the MRS is the absolute value of the
    slope of the curve at various points. Note the slope
    changes from point to point. In absolute value the
    fraction gets smaller the farther down the curve one
    moves. This is another way of saying the curve gets

                                            feature 2
In general, it is assumed that consumers value additional units
of a good less and less the more they have of the good. (Or
you could say when consumers give up good x they require
more and more of good y the less of good x they start with.)
The indifference curve gets flatter.
This notion is summarized with the phrase – diminishing
marginal rates of substitution.

y        Indifference curves - feature 3

        Indifference Map
        Every point in the graph
        has one, and only one,
        indifference curve running
        through it.
        Curves farther out from
        the origin have more
    x   So, the consumer can
        compare every bundle and
        make a determination of
        preference or indifference.

y                               Indifference curves - feature 4

                          Indifference curves for an
                          individual do not cross. Say they
                          did, like in this diagram. Then
             C            individual would be
     A                    indifferent to A and B,
         B                indifferent to A and C,
                          and thus by logic should be
                          indifferent to B and C.

    But C has more of both goods compared to B and thus C
    is preferred to B. So the curves can not cross for an
    individual. Transitivity of preferences holds.
                           Indifference curves - feature 5

 Different people can have different general
  shapes of indifference curves. Some are
  relatively steep and some are relatively flat.
 On the next slide I will put two peoples’
  indifference curves and they will cross.
  Before we said one individual’s curves could
  not cross.

                               Indifference curves - feature 5

          Mr. A

Mr. B
Note how Mr. A has a steeper curve than Mr. B. From the
point where the curves cross if both give up a unit of
x, note how Mr. A has to be given more y to
make up for the loss of x than Mr. B. Mr. A is said to have
a relatively strong preference for x because he needs much
more y in return for the one unit of x given up.
A math example of a utility function might be
U = sqrt(XY) – this means utility is a function of the square root of
the product of the amount of x and the amount of y a person would
To get an indifference curve pick a value of U. Let’s say U = 4.
Then some points on the indifference curve would be
X      Y
16     1
1      16
4      4
8      2
2      8                                                                18
             indifference curve when U = sqrt(xy) = 4

    16        1, 16

     8          2, 8
     4                 4, 4
     2                        8, 2
                                          16, 1
         0             5        10   15           20


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