indiffrence curves

Chapter 3 1©2005 Pearson Education, Inc.

Indifference Curves:An Example (pp. 65 - 79)

4010H

2010G

4030E

2040D

5010B

3020A

Units of ClothingUnits of FoodMarket Basket



�Graph the points with one good on the x-axis and one good on the y-axis

�Plotting the points, we can make someimmediate observations aboutpreferences�The more, the better


The consumer prefersA to all combinations

in the yellow box, whileall those in the pink

box are preferred to A.


Food

10

20

30

40

10 20 30 40

Clothing 50

G

A

EH

B

D



�Points such as B & D have more of onegood but less of another compared to A�Need more information about consumer

ranking

�Consumer may decide they areindifferent between B, A and D�We can then connect those points with an

indifference curve


•Indifferentbetween points B,A, & D•E is preferred toany points on theindifference curveU1•Points on U1 arepreferred to H & G


Food

10

20

30

40

10 20 30 40

Clothing50

U1GD

A

EH

B


Indifference Curves (pp. 65 - 79)

�Any market basket lying northeast of anindifference curve is preferred to anymarket basket that lies on theindifference curve

�Points on the curve are preferred topoints southwest of the curve



� Indifference curves slope downward tothe right�If they sloped upward, they would violate the

assumption that more is preferred to less



� To describe preferences for allcombinations of goods/services, we havea set of indifference curves – anindifference map�Each indifference curve in the map shows

the market baskets among which the personis indifferent


U2

U3

Indifference Map (pp. 65 - 79)

Food

Clothing

U1

ABD

Market basket Ais preferred to B.Market basket B ispreferred to D.


Indifference Maps (pp. 65 - 79)

� Indifference maps give more informationabout shapes of indifference curves�Indifference curves cannot cross

� Violates assumption that more is better

�Why? What if we assume they can cross?


Indifference Maps (pp. 65 - 79)

Food

Clothing

•B is preferred to D•A is indifferent to B & D•B must be indifferent toD but that can’t be if B ispreferred to D. Acontradiction•Other example: On a map, twocontours never crosseach other.

U1

U1

U2

U2

A

B

D



� The shapes of indifference curvesdescribe how a consumer is willing tosubstitute one good for another�A to B, give up 6 clothing to get 1 food

�D to E, give up 2 clothing to get 1 food

� The more clothing and less food a personhas, the more clothing they will give up toget more food


A

B

D

EG

-1

-6

1

1

-4

-21

1

Observation: The amountof clothing given up for 1 unit of food decreasesfrom 6 to 1


Food

Clothing

2 3 4 51

2

4

6

8

10

12

14

16



�We measure how a person trades onegood for another using the marginal rateof substitution (MRS)�It quantifies the amount of one good a

consumer will give up to obtain more ofanother good, or the individual terms of trade

�From a geometric viewpoint, it is measuredby the slope of the indifference curve


Marginal Rate of Substitution (pp. 65

- 79)

Food2 3 4 51

Clothing

2

4

6

8

10

12

14

16 A

B

D

EG

-6

1

1

11

-4

-2-1

MRS = 6

MRS = 2

FCMRS Δ

Δ−=



- 79)

From A to B, give up 6 clothing to get 1 food.That is,

ΔF=2-1=1, ΔC=10-16 =-6; MRS=- ΔC / ΔF=6

From D to E, , give up 2 clothing to get 1 food;ΔF=4-3=1, ΔC=4-6 =-2; MRS =- ΔC / ΔF= 2



- 79)

� Indifference curves are convex�As more of one good is consumed, a consumer would

prefer to give up fewer units of a second good to getadditional units of the first one. As food becomes lessscarce, he/she would give up less of clothing for anadditional food.

� Consumers generally prefer a balanced marketbasket (preference for varieties; the Doctrine ofthe Mean in a Chinese classic)



- 79)

� The MRS decreases as we move downthe indifference curve�Along an indifference curve there is a

diminishing marginal rate of substitution.

�The MRS went from 6 to 4 to 1



- 79)

� Indifference curves with different shapesimply a different willingness to substitute

[That is, an indifference map is a conceptto represent one’s preference for marketbaskets.]

� Two polar cases are of interest�Perfect substitutes

�Perfect complements



- 79)

�Perfect Substitutes�Two goods are perfect substitutes when the

marginal rate of substitution of one good forthe other is constant

�Example: a person might consider applejuice and orange juice perfect substitutes� They would always trade 1 glass of OJ for 1

glass of Apple Juice

� Find your own examples.


Consumer Preferences (pp. 65 - 79)

Orange Juice(glasses)

Apple Juice

(glasses)

2 3 41

1

2

3

4

0

PerfectSubstitutes



�Perfect Complements�Two goods are perfect complements when

the indifference curves for the goods areshaped as right angles

�Example: If you have 1 left shoe and 1 rightshoe, you are indifferent between havingmore left shoes only� Must have one right for one left. That’s why we

always get a pair of shoes, not one by one.

� Find your own examples.



Right Shoes

LeftShoes

2 3 41

1

2

3

4

0

PerfectComplements


Consumer Preferences:An Application (pp. 65 - 79)

� In designing new cars, automobileexecutives must determine how muchtime and money to invest in restylingversus increased performance�Higher demand for car with better styling and

performance

�Both cost more to improve


Consumer Preferences:An Application (pp. 65 - 79)

�An analysis of consumer preferenceswould help to determine where to spendmore on change: performance or styling

�Some consumers will prefer better stylingand some will prefer better performance

� In recent years we have seen more andmore SUVs on our roads. Certainly moreowners/drivers prefer SUVs to otherstyles.



� The theory of consumer behavior doesnot required assigning a numerical valueto the level of satisfaction. Can you tellthe level of satisfaction from your monthlybasket?

�Although ranking of market baskets isgood, sometimes numerical value isuseful



�Utility�A numerical score (concept) representing the

satisfaction that a consumer gets from agiven market basket. The concept of utility wasborn before that of consumer preference.

�If buying 3 copies of Microeconomics makesyou happier than buying one shirt, then wesay that the books give you more utility thanthe shirt


Utility (pp. 65 - 79)

�Utility function�Formula that assigns a level of utility to

individual market baskets

�If the utility function is

U(F,C) = F + 2CA market basket with 8 units of food and 3 units of

clothing gives a utility of

14 = 8 + 2(3)


Utility - Example (pp. 65 - 79)

4 + 2(4) = 1244C

6 + 2(4) = 1446B

8 + 2(3) = 1438A

UtilityClothingFoodMarketBasket

Consumer is indifferent between A & B andprefers both to C.


Utility - Example (pp. 65 - 79)

�Baskets for each level of utility can beplotted to get an indifference curve�To find the indifference curve for a utility of

14, we can change the combinations of foodand clothing that give us a utility of 14


Utility - Another Example (pp. 65 - 79)

Food10 155

5

10

15

0

Clothing

U1 = 25

U2 = 50

U3 = 100A

B

C

Basket U = FC C 25 = 2.5(10) A 25 = 5(5) B 25 = 10(2.5)


Utility (pp. 65 - 79)

� Although we numerically rank baskets andindifference curves, numbers are ONLY forranking

� A utility of 4 is not necessarily twice as good asa utility of 2. A umber assigned to a utility levelDOES NOT have any meaning.

� There are two types of rankings�Ordinal ranking; Ordinal Utility Function Think of a number on your ticket when you are in a

waiting line.�Cardinal ranking; Cardinal Utility Function Think of the total number of students in this class.


Budget Constraints (pp. 79 - 83)

�Preferences do not explain all ofconsumer behavior

�Budget constraints limit an individual’sability to consume in light of the pricesthey must pay for various goods andservices



� The Budget Line (Constraint)�Indicates all combinations of two

commodities for which total money spentequals total income

�We assume only 2 goods are consumed, sowe do not consider savings


The Budget Line (pp. 79 - 83)

� Let F equal the amount of foodpurchased, and C is the amount ofclothing

�Price of food = PF and price ofclothing = PC

� Then PFF is the amount of money spenton food, and PCC is the amount of moneyspent on clothing


ICPFPCF =+


� The budget line then can be written:

All income is allocated to food (F) and/or clothing(C)



�Different choices of food and clothing canbe calculated that use all income�These choices can be graphed as the budget

line

�Example:�Assume income of $80/week, PF = $1 and PC

= $2



$80080G

$801060E

$802040D

$803020B

$80400A

IncomeI = PFF + PCC

Clothing

PC = $2

Food

PF = $1

MarketBasket


C

F

P

P

F

C Slope -

2

1- ==

Δ

Δ=


10

20

A

B

D

E

G

(I/PC) = 40

Food40 60 80 = (I/PF)20

10

20

30

0

Clothing



�As consumption moves along a budgetline from the intercept, the consumerspends less on one item and more on theother

� The slope of the line measures therelative cost of food and clothing

� The slope is the negative of the ratio ofthe prices of the two goods



� The slope indicates the rate at which thetwo goods can be substituted withoutchanging the amount of money spent

It represents exchange ratio or terms oftrade in market places.

�We can rearrange the budget lineequation to make this more clear



YXP

P

P

I

YPXPI

YPXPI

Y

X

Y

YX

YX

=−

=−

+=

indiffrence curves

Business

indifference maps

set of indifference

indifference curve points

indifference curve u1

better2005 pearson education

less2005 pearson education

points b

food f