Indifference curve and consumer choice
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Indifference Curve and Consumer Choice. Overview . Illustrated using example of choices on movies and concerts Assumptions of preference ______________________ ______________________ ______________________ Indifference curve Consumer choice maximize utility with constraint of budget.

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Overview
Overview

  • Illustrated using example of choices on movies and concerts

  • Assumptions of preference

    • ______________________

    • ______________________

    • ______________________

  • Indifference curve

  • Consumer choice

    • maximize utility with constraint of budget


Assumption 3 more is better
Assumption 3: More is better

No. of movies per month

D?

B?

A

C?

E?

No. of concerts per month


Assumption 3 nonsatiation more is better
Assumption 3: Nonsatiation -- More is better

No. of movies per month

more preferred

?

B

A

C

B preferred to A

A preferred to C

less preferred

?

No. of concerts per month


Assumption 1 can rank any two bundles
Assumption 1: Can rank any two bundles

No. of movies per month

‘More is better’ means that as we go northeast from C to B, utility increases

B

A

C

No. of concerts per month


Indifference Curve:All Combinations of two Goods that yield the same level of utility (Make the consumers equally well off.)

No. of movies per Month

After giving you an additional concert, how many movies could we take away from you and leave you no better or worse off than D?

B

D

A

E

C

U0

No. of concerts per month


Two things about the indifference curve
Two things about the Indifference curve

  • First, it slopes _____. This follows the assumption about preferences _________.

  • Second, notice the curvature about the indifference curve. As we move downward and rightward along it, the curve becomes _________. Why?


Diminishing Marginal Utility:As No. of concert increases, takes away decreasing amounts of movies to leave utility unchanged

No. of movies per month

Along an indifference curve,

As No. of movies decreases and No. of concerts increases, Marginal utility from an additional movie ____ andMarginal utility from an additional concert _______.

ΔM1

ΔM2

ΔM3

U0

No. of concerts per month

ΔC

ΔC

ΔC


Marginal rate of substitution the absolute value of the slope of the indifference curve
Marginal Rate of Substitution– the absolute value of the slope of the indifference curve.

What does the slope (without the minus sign) of indifference

Curve mean?

The maximum amount of movie Max would willingly trade for one more concert.

No. of movies per month

ΔM1

ΔM2

ΔM3

U0

No. of concerts per month

ΔC

ΔC

ΔC


Marginal rate of substitution
Marginal Rate of Substitution

Along the indifference curve,

the slope _______in absolute value;

the MRS _______ when No. of movies decreases and No. of concert increases.

No. of movies per month

ΔM1

ΔM2

ΔM3

U0

No. of concerts per month

ΔC

ΔC

ΔC


Indifference map ranking indifference curves
Indifference Map -Ranking Indifference Curves

Any point on a higher indifference curve is preferred to any point on a lower one.

No. of movies per month

B

A

U1

C

U0

U-1

No. of concerts per month


Budget set all combinations of goods that lie on or inside the budget line
Budget Set: All combinations of goods that lie on or inside the budget line

No. of movies per month

15

Not affordable

affordable

5

No. of concerts per month


Combine budget line with indifference curve
Combine budget line with indifference curve the budget line

No. of movies per month

The optimal combination of

Goods for a consumer is the

Point on the budget line where

an indifference curve is tangent

to the budget line.

15

C

B

U2

U1

A

U0

5

No. of concerts per month


Combine budget line with indifference curve1
Combine budget line with indifference curve the budget line

No. of movies per month

The absolute value of the slope of the budget line=__________

The absolute value of the slope

of the indifference curve =______

The optimal decision-making rule

is _________________

15

C

B

U2

U1

A

U0

5

No. of concerts per month


Changes in income
Changes in income the budget line

30

No. of movies per month

A rise in income, with no change in prices, leads to a new quantity demanded for each good. Whether a particular good is normal (quantity demanded increases) or inferior (quantity demanded decreases) depends on the individual’s __________, as represented by his ____________.

15

C

B

U2

U1

A

U0

5

10

No. of concerts per month


Changes in price
Changes in Price the budget line

No. of movies per month

The drop in the price of

concert rotates Max’s

budget line ______.

Based on his difference

curves, he will choose

___. What if we dropped

the price of concert again?

How can we derive

Max’s individual demand

curve for concert?

15

B

C

U2

U1

A

U0

10

5

No. of concerts per month


Income and substitution effects
Income and Substitution Effects the budget line

  • Demand curve actually summarizes impact of two separate effects of price change on quantity demanded

  • Substitution effects

    • As the price of concert falls, its relative price ( relative to movies) _____.

    • Max substitutes concerts in place of movies whose prices have not changed.

    • It always moves quantity demanded in the opposite direction to the price change

      • When price decreases (increases), substitution effect works to _______ (_______) quantity demanded.


The income effect
The Income Effect the budget line

  • When the price of concert drops, Max’s budget line rotates rightward. The price decline of concert ____ his total purchasing power over both goods.

  • Income effect can work to either increase or decrease the quantity of a good demanded, depending on whether the good is normal or inferior.

    If concert is a normal good, the income effect of a price cut will lead Max to consume _____ of them.

    If concert is an inferior good, the income effect of a price cut will lead Max to consume _______ of them.


Figure 7 combining income and substitution effects

Ultimate the budget line

Effect

(Almost Always)

Figure 7: Combining Income and Substitution Effects

Price Decrease:

Substitution Effect

P

QD

Þ

QD

QD

if normal

Purchasing Power

QD

if inferior

Price Increase:

Substitution Effect

P

QD

Þ

QD

QD

if normal

Purchasing Power

QD

if inferior


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