1. Indifference Analysis Appendix to Chapter 5

2. 2 Indifference Curves Indifference analysis is an alternative way of explaining consumer choice that does not require an explicit discussion of utility. Indifferent: the consumer has no preference among the choices. Indifference curve: a curve showing all the combinations of two goods (or classes of goods) that the consumer is indifferent among.

3. Indifference Curve 3 All points along the indifference curve represent combinations that are equally satisfying

4. 4 Indifference Curves: Shape A common shape for an indifference curve is downward sloping. – For the consumer to be indifferent to the bundle of goods chosen, as less of one good is consumed, more of another must be consumed.

5. 5 Indifference Curves: Shape (2) The indifference curves are not likely to be vertical, horizontal, or upward sloping. – A vertical or horizontal indifference curve holds the quantity of one of the goods constant, implying that the consumer is indifferent to getting more of one good without giving up any of the other good. – An upward-sloping curve would mean that the consumer is indifferent between a combination of goods that provides less of everything and another that provides more of everything. – Rational consumers usually prefer more to less.

6. 6 Indifference Curve Shapes Improbable or impossible shapes:

7. 7 Indifference Curves: Slope The slope or steepness of indifference curves is determined by consumer preferences. – It reflects the amount of one good that a consumer must give up to get an additional unit of the other good while remaining equally satisfied. – This relationship changes according to diminishing marginal utility—the more a consumer has of a good, the less the consumer values an additional value of that good. This is shown by an indifference curve that bows in toward the origin.

8. Marginal Rate of Substitution 8 The slope of an indifference curve represents the rate at which a consumer would be willing to exchange one good for another – with indifference That ratio is called the Marginal Rate of Substitution

9. 9 Indifference Curves: No Crossing Allowed! Indifference curves cannot cross. If the curves crossed, it would mean that the same bundle of goods would offer two different levels of satisfaction at the same time. If we allow that the consumer is indifferent to all points on both curves, then the consumer must not prefer more to less. There is no way to sort this out. The consumer could not do this and remain a rational consumer.

10. 10 Indifference Curves Cannot Cross!

11. 11 Indifference Map An indifference map is a complete set of indifference curves. It indicates the consumer’s preferences among all combinations of goods and services. The farther from the origin the indifference curve is, the more the combinations of goods along that curve are preferred.

12. 12 Indifference Map

13. 13 Budget Constraint The indifference map only reveals the ordering of consumer preferences among bundles of goods. It tells us what the consumer is willing to buy. It does not tell us what the consumer is able to buy. It does not tell us anything about the consumer’s buying power. The budget line shows all the combinations of goods that can be purchased with a given level of income.

14. 14 The Budget Line

15. 15 Consumer Equilibrium The indifference map in combination with the budget line allows us to determine the one combination of goods and services that the consumer most wants and is able to purchase. This is the consumer equilibrium. The demand curve for a good can be derived from indifference curves and budget lines by changing the price of one of the goods (leaving everything else the same) and finding the equilibrium points.

16. 16 Consumer Equilibrium The consumer maxi- mizes satisfaction by purchasing the combination of goods that is on the indifference curve farthest from the origin but attainable given the consumer’s budget.

17. 17 Deriving the Demand Curve By changing the price of one of the goods and leaving everything else the same, we can derive the demand curve. In (a), the price of a gallon of gasoline doubles, rotating the budget line from Y 1 to Y 2. The consumer equilibrium moves from point C to E, and the quantity demanded of gasoline falls from 3 to 2.

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