Presentation on theme: "Indifference curves Indifference curves represent a summary of the consumer’s taste and preferences for various products."— Presentation transcript:
1 Indifference curvesIndifference curves represent a summary of the consumer’s taste and preferences for various products.
2 There is no accounting for the taste of the consumer 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.
3 The amount of good y a consumer may have is measured vertically Diagram used in analysisgood yThe amount of good y a consumer may have is measured verticallygood xThe amount of good x is measured on the horizontal axis.This type of diagram is used extensively when considering the behavior of consumers.
4 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.yThis is one type ofindifference curve. We assume theindividual is equally happyat point A or B or any otherpoint on the indifferencecurve.ABx
5 Indifference curves - feature 1 We assume more goods are preferred to less and thus indifference curves slope downward to the right.ySay the individual is atthe point in the middleof the graph. Keep thisin mind as we explorethe following screens.x
6 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.
7 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.
8 slopeIn 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.
9 Indifference curves - feature 2 ySay the consumer is at point A. If the consumer gives up one unit of x, m units of y must be given back to hold the consumer at a constant level of utility.You could say the consumer is willing to trade 1 unit of x to get m units of y.BmAx1
10 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.
11 But more is given in return if point A is the initial point. A Indifference curves - feature 2yYou 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, some y must be given in return.But more is given in return if point A is the initial point.ABxThe point is the less you have of something(like x atpoint A compared to point B), the more of other thingsyou must be given in return to compensate for the loss of the one unit, assuming the same level of utility is obtained.
12 We can think of the MRS as a fraction: Indifference curves - feature 2The 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 flatter.
13 feature 2In 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.
14 Every point in the graph has one, and only one, Indifference curves - feature 3yIndifference MapEvery point in the graphhas one, and only one,indifference curve running through it.Curves farther out fromthe origin have moreutility.So, the consumer can compare every bundle and make a determination of preference or indifference.x
15 and thus by logic should be indifferent to B and C. C A B Indifference curves - feature 4yIndifference curves for an individual do not cross. Say they did, like in this diagram. Thenindividual would beindifferent to A and B,indifferent to A and C,and thus by logic should be indifferent to B and C.CABxBut C has more of both goods compared to B and thus Cis preferred to B. So the curves can not cross for anindividual. Transitivity of preferences holds.
16 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.
17 Note how Mr. A has a steeper curve than Mr. B. From the Indifference curves - feature 5yMr. AMr. BxNote how Mr. A has a steeper curve than Mr. B. From thepoint where the curves cross if both give up a unit ofx, note how Mr. A has to be given more y tomake 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.
18 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 get.To get an indifference curve pick a value of U. Let’s say U = 4. Then some points on the indifference curve would beX Y16 11 164 48 22 8