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INDIFFERENCE ANALYSIS Indifference curvesIndifference curves –constructing an indifference curve –the shape of an indifference curve –diminishing marginal.

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Presentation on theme: "INDIFFERENCE ANALYSIS Indifference curvesIndifference curves –constructing an indifference curve –the shape of an indifference curve –diminishing marginal."— Presentation transcript:

1 INDIFFERENCE ANALYSIS Indifference curvesIndifference curves –constructing an indifference curve –the shape of an indifference curve –diminishing marginal rate of substitution –an indifference map The budget lineThe budget line –constructing a budget line –effect of a change in income –effect of a change in price

2 a Pears Oranges Pears 30 24 20 14 10 8 6 Oranges 6 7 8 10 13 15 20 Point abcdefgabcdefg Constructing an indifference curve

3 Deriving the marginal rate of substitution (MRS) a b Units of good Y Units of good X 26 67

4 a b Units of good Y Units of good X 26 67 Y = 4 X = 1 MRS = 4 Deriving the marginal rate of substitution (MRS)

5 a b Units of good Y Units of good X 26 67 c d Y = 4 X = 1 Y = 1 X = 1 MRS = 1 MRS = 4 13 14 9 Deriving the marginal rate of substitution (MRS)

6 Units of good Y Units of good X I1I1 I2I2 I3I3 I4I4 I5I5 An indifference map

7 Units of good Y Units of good X a b Units of good X 0 5 10 15 Units of good Y 30 20 10 0 Point on budget line a b Assumptions P X = £2 P Y = £1 Budget = £30 A budget line

8 Units of good Y Units of good X Assumptions P X = £2 P Y = £1 Budget = £40 16 7 m n Budget = £40 Budget = £30 Effect of an increase in income on the budget line

9 Effect on the budget line of a fall in the price of good X Units of good Y Units of good X Assumptions P X = £1 P Y = £1 Budget = £30 B1B1 B2B2 a b c

10 INDIFFERENCE ANALYSIS The optimum consumption pointThe optimum consumption point –equating the marginal rate of substitution with the price ratio The effect of a change in incomeThe effect of a change in income –the income–consumption curve –the Engel curve –income elasticity of demand and the income– consumption curve –the effect of a rise in income on the demand for an inferior good

11 I1I1 I2I2 I3I3 I4I4 I5I5 Units of good Y O Units of good X Budget line Finding the optimum consumption

12 I1I1 I2I2 I3I3 I4I4 I5I5 Units of good Y O Units of good X r s t Y1Y1 X1X1 v u Same slope at t of indifference curve and budget line

13 Units of good Y O Units of good X B1B1 Effect on consumption of a change in income I1I1

14 I2I2 Units of good Y O Units of good X B1B1 B2B2 I1I1 Effect on consumption of a change in income

15 I2I2 Units of good Y O Units of good X B1B1 B2B2 B3B3 B4B4 I1I1 I3I3 I4I4 Effect on consumption of a change in income

16 I2I2 Units of good Y O Units of good X B1B1 B2B2 B3B3 B4B4 I1I1 I3I3 I4I4 Income–consumption curve Effect on consumption of a change in income

17 B1B1 B2B2 B3B3 I3I3 I2I2 I1I1 Income-consumption curve Bread Income (£) CDs Qb3Qb3 Qb2Qb2 Qb1Qb1 Y3Y3 Y2Y2 Y1Y1 Q cd 3 Q cd 2 Q cd 1 Q cd 3 Q cd 2 Q cd 1 a b c a b c Deriving an Engel curve from an income–consumption curve

18 B1B1 B2B2 B3B3 I3I3 I2I2 I1I1 Income-consumption curve Bread Income (£) CDs Qb3Qb3 Qb2Qb2 Qb1Qb1 Y3Y3 Y2Y2 Y1Y1 Q cd 3 Q cd 2 Q cd 1 Q cd 3 Q cd 2 Q cd 1 Engel curve a b c a b c Deriving an Engel curve from an income–consumption curve

19 Effect of a rise in income on the demand for an inferior good Units of good Y (normal good) Units of good X (inferior good) O I1I1 B1B1 a

20 Effect of a rise in income on the demand for an inferior good Units of good Y (normal good) Units of good X (inferior good) O I2I2 I1I1 B1B1 B2B2 a b

21 Effect of a rise in income on the demand for an inferior good Units of good Y (normal good) Units of good X (inferior good) O Income–consumption curve I2I2 I1I1 B1B1 B2B2 a b

22 Effect of a fall in the price of good X Units of good Y Units of good X Assumptions P X = £2 P Y = £1 Budget = £30 B1B1 I1I1 j

23 Units of good Y Units of good X Assumptions P X = £1 P Y = £1 Budget = £30 B1B1 I1I1 j I2I2 B2B2 k Effect of a fall in the price of good X a

24 Units of good Y Units of good X B1B1 I1I1 j I2I2 B2B2 k Price–consumption curve Effect of a fall in the price of good X a

25 B1B1 B2B2 B3B3 I3I3 I2I2 I1I1 I4I4 B4B4 Expenditure on all other goods Units of good X a b c d Further falls in the price of X Deriving a demand curve from a price–consumption curve

26 B1B1 B2B2 B3B3 I3I3 I2I2 I1I1 I4I4 B4B4 Expenditure on all other goods Units of good X a Price - consumption curve b c d Deriving a demand curve from a price–consumption curve

27 B1B1 B2B2 B3B3 I3I3 I2I2 I1I1 I4I4 B4B4 Expenditure on all other goods Units of good X a Price - consumption curve b c d Price of good X Units of good X a b P1P1 P2P2 Q1Q1 Q2Q2 Deriving a demand curve from a price–consumption curve

28 B1B1 B2B2 B3B3 I3I3 I2I2 I1I1 I4I4 B4B4 Expenditure on all other goods Units of good X a Price - consumption curve b c d Price of good X Units of good X a b c d P1P1 P2P2 P3P3 P4P4 Q1Q1 Q2Q2 Q3Q3 Q4Q4 Deriving a demand curve from a price–consumption curve

29 B1B1 B2B2 B3B3 I3I3 I2I2 I1I1 I4I4 B4B4 Expenditure on all other goods Units of good X a Price - consumption curve b c d Price of good X Units of good X a b c d Demand P1P1 P2P2 P3P3 P4P4 Q1Q1 Q2Q2 Q3Q3 Q4Q4 Deriving a demand curve from a price–consumption curve

30 INDIFFERENCE ANALYSIS The effect of changes in priceThe effect of changes in price –the price–consumption curve –deriving the individual's demand curve Income and substitution effects of a price changeIncome and substitution effects of a price change –a normal good –an inferior good –a Giffen good (a special type of inferior good)

31 Units of Good X Units of good Y I1I1 I2I2 I3I3 I4I4 I5I5 I6I6 f B1B1 Income and substitution effects: normal good QX1QX1

32 Units of Good X Units of good Y I1I1 I2I2 I3I3 I4I4 I5I5 I6I6 f B1B1 Income and substitution effects: normal good QX1QX1 h B2B2 QX3QX3 Rise in the price of good X

33 Units of Good X Units of good Y I1I1 I2I2 I3I3 I4I4 I5I5 I6I6 f B1B1 Income and substitution effects: normal good QX1QX1 h B2B2 Substitution effect g QX2QX2 B 1a Substitution effect of the price rise

34 Units of Good X Units of good Y I1I1 I2I2 I3I3 I4I4 I5I5 I6I6 f B1B1 Income and substitution effects: normal good QX1QX1 h B2B2 QX3QX3 Substitution effect g QX2QX2 B 1a Income effect of the price rise Income effect

35 Units of Good Y Units of Good X Units of good Y f B1B1 Income and substitution effects: Inferior (non-Giffen) good QX1QX1 I1I1 I2I2

36 Units of Good Y Units of Good X Units of good Y f B1B1 Income and substitution effects: Inferior (non-Giffen) good QX1QX1 B2B2 h QX3QX3 I1I1 I2I2 Rise in the price of good X

37 Units of Good Y Units of Good X Units of good Y f B1B1 Income and substitution effects: Inferior (non-Giffen) good QX1QX1 B2B2 g h QX2QX2 I1I1 I2I2 Substitution effect B 1a Substitution effect of the price rise

38 Units of Good Y Units of Good X Units of good Y f B1B1 Income and substitution effects: Inferior (non-Giffen) good QX1QX1 B2B2 g h QX2QX2 QX3QX3 I1I1 I2I2 Substitution effect Income effect B 1a Income effect of the price rise

39 Units of Good Y Units of Good X Units of good Y f B1B1 Income and substitution effects: Giffen good QX1QX1 I1I1 I2I2

40 Units of Good Y Units of Good X Units of good Y f B1B1 Income and substitution effects: Giffen good QX1QX1 B2B2 h QX3QX3 I1I1 I2I2 Rise in the price of good X

41 Units of Good Y Units of Good X Units of good Y f B1B1 Income and substitution effects: Giffen good QX1QX1 B2B2 h QX3QX3 I1I1 I2I2 g QX2QX2 B 1a Substitution effect of the price rise

42 Units of Good Y Units of Good X Units of good Y f B1B1 Income and substitution effects: Giffen good QX1QX1 B2B2 h QX3QX3 I1I1 I2I2 g QX2QX2 Substitution effect Income effect Income effect of the price rise B 1a

43 INDIFFERENCE ANALYSIS The effect of a change in price on the demand for other goodsThe effect of a change in price on the demand for other goods The usefulness of indifference analysisThe usefulness of indifference analysis –superiority of using ordinal measures –limitations of indifference analysis


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