Indifference Curve and Consumer Choice

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Indifference Curve and Consumer Choice

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Overview

• Illustrated using example of choices on Food and
  Clothing consumption
• Assumptions of preference
• Non-satiation
• Completeness
• Diminishing marginal utility
• Indifference curve
• Consumer choice
• maximize utility with constraint of budget

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Assumption 1 Nonsatiation -- More is
better
clothing
D?
B?
A
C?
E?
food
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Assumption 1 Nonsatiation -- More is
better
clothing
more preferred
?
B
A
C
B preferred to A A preferred to C
less preferred
?
food
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Assumption 2 Completeness -- Can rank any two
bundles
clothing
Nonsatiation means that as we go northeast from C
to B, utility increases
B
A
C
food
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Assumption 2 Completeness -- Can rank any
two bundles
clothing
On every arc from C to B, there will be a point
indifferent to A
B
X
A
X
C
food
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Indifference CurveAll Combinations of Goods
that yield the same level of utility
clothing
B
X
A
X
C
U0
food
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Ranking Indifference Curves
Heaven on Earth
clothing
B
A
U1
C
U0
U-1
food
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Assumption 3 Diminishing Marginal Utility

• As consumption increases, added utility falls
• Insures convex indifference curves

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Deriving a graphical representationThe budget
line

• Y PF F PC C
• To put this into the same space with C on the
  vertical axis and F on the horizontal axis, solve
  for C
• PC C Y - PF F
• C (Y/ PC ) - (PF / PC )F

Constant
Slope
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Deriving a graphical representation (continued)

• C (Y/ PC ) - (PF / PC )F
• Suppose Y 100
• PF 5
• PC 1
• C (100/ 1 ) - (5/ 1 )F
• C 100 - 5 F

Constant
Slope
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C (Y/ PC ) - (PF / PC )FY100 PC 1 PF 5
C
Note slope is (opportunity cost of food)
-(PF/PC) -amount of clothing given up to buy
food -5 units of clothing
100
C 100 - 5 F
20
F
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Budget Set All combinations of goods that lie
on or inside the budget line
C
100
Not affordable
affordable
20
F
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Diminishing Marginal UtilityAs Clothing
decreases, takes increasing amounts of food to
leave utility unchanged
clothing
Along an indifference curve, As C decreases and
F increases, MUF decreases and MUC increases
?C
?C
?C
U0
food
?F1
?F2
?F0
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Diminishing Marginal Utility -- Marginal Rate
of Substitution
clothing
MRS (?C/?F) slope of indifference curve
-(?C/?F) (?U/?U) -(?U/?F)/(?U/?C) -(MU
F/MUC)
?C
?C
?C
U0
food
?F1
?F2
?F0
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Diminishing Marginal Utility -- Marginal Rate
of Substitution
clothing
MRS slope -(MUF / MUC)
Along an indifference curve, As C decreases and
F increases, MUF decreases and MUC
increases Slope decreases in absolute value
?C
?C
?C
U0
food
?F1
?F2
?F0
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Combine budget line with indifference curve
C
100
C
B
U2
U1
A
U0
20
F
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Optimum slope of the budget line slope of
the indifference curve
C
100
(PF / PC) (MUF / MUC)
B
U1
20
F