2 Budget lineGood 215050100Good 115010050Points on the budget line indicate all the bundles of goods that the consumer can afford.
3 Indifference CurveIndifference curve: locus of bundles that provide the consumer with the same level of satisfaction
4 Indifference curves Good 2 (x 2) w a 20 b 140 100 Good 1 (x 1) 10 10Points on the same indifference curve represent bundles yielding the same amount of utility.
5 Indifference Curves Indifference map Set of indifference curves for a consumerEvery bundleOn an indifference curveIndifference curvesFarther from origin ->Higher utility
6 The Shape of Indifference Curves Cannot slope upwardNonsatiation assumptionCannot cross each otherTransitivity and nonsatiation assumptionsFarther from the origin – higher utilityAre bowed in toward the originConvexity assumptionFarther from the origin - higher utility
7 Indifference curves cannot slope upward Good 2 (x 2)EBxayDCGood 1 (x 1)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.
8 Indifference curves cannot cross each other Good 2 (x 2)I2I1abcGood 1 (x 1)If indifference curves I1 and I2 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 assumption
9 Farther from the origin -> higher utility Good 2 (x 2)Bundle w must be preferred to bundle a because it contains more of both goodswaGood 1 (x 1)
10 Bowed-in (a) (b) Good 2 (x 2) Good 2 (x 2) a a c c b b Good 1 (x 1) Good 1 (x 1)(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
11 The Marginal Rate of Substitution Marginal rate of substitution (MRS)Particular point on indifference mapOne consumerRatio of exchanging goodsSame utilityMRS = - ∆x2 / ∆x1
12 The Marginal Rate of Substitution Diminishing marginal rate of substitutionFrom convexityMove along the indifference curveSame utility levelMRS decreases
13 Convex preferences and the MRS Good 2 (x 2)10960100aI1+∆x2-∆x1b-∆x1+∆x2cdGood 1 (x 1)1020100110As the consumer is given bundles containing more and more of good 2, she values an individual unit of good 2 less and less
14 Indifference Curves and Tastes Flat indifference curvesGoods that yield no utilityStraight-line indifference curvesGoods that are perfect substitutesMRS - constant along an indifference curveIn a two-good worldIndifference curve - straight line
15 (a) (b) Good 2 (x 2) Good 2 (x 2) 9 5 4 10 +∆x2 a -∆x1 +∆x2 -∆x1 Good 1 (x 1)3811(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.
16 Indifference Curves and Tastes Right-angle indifference curvesGoods that are perfect complementsMust be consumed in a fixed ratio to produce utilityIn a two-good worldRight angle indifference curvesBowed-out indifference curvesNonconvex preferences
17 (c) (d) Good 2 (x 2) 10 11 Good 2 (x 2) +∆x2 +∆x2 -∆x1 b +∆x2 -∆x1 b a I1-∆x1aGood 1 (x 1)56Good 1 (x 1)(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.
18 Perfect substitutes Pepsi Coke Mary’s marginal rate of substitution is constant at any bundle of Pepsi and Coke.
19 Optimal Consumption Bundle Maximize consumer’s utilityWithin 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
20 The optimal consumption bundle Good 2 (x 2)BB’+1x-4-3zek+1nmFGood 1 (x 1)At the optimal point e, the indifference curve is tangent to the boundary BB’ of the economically feasible consumption set.