indifference curves

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Presentation Transcript

Indifference Curve Analysis : 

Indifference Curve Analysis

Slide 2: 

THE BUDGET LINE: What is Attainable 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12

Slide 3: 

8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 Quantity of A Quantity of B THE BUDGET LINE: What is Attainable

Slide 4: 

8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 Quantity of A Quantity of B THE BUDGET LINE: What is Attainable

Slide 5: 

8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 Quantity of A Quantity of B THE BUDGET LINE: What is Attainable

Slide 6: 

8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 Quantity of A Quantity of B THE BUDGET LINE: What is Attainable

Slide 7: 

8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 (Attainable) Quantity of A Quantity of B (Unattainable) THE BUDGET LINE: What is Attainable

Slide 8: 

THE BUDGET LINE: What is Attainable 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 (Attainable) Quantity of A Quantity of B (Unattainable)

Slide 9: 

THE BUDGET LINE: What is Attainable 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 (Attainable) Quantity of A Quantity of B (Unattainable)

Slide 10: 

INDIFFERENCE CURVES What is Preferred Quantity of A Quantity of B 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 An Indifference Schedule j 12 2 j

Slide 11: 

Quantity of A Quantity of B 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 An Indifference Schedule Combi- nation Units of A Units of B j 12 2 k 6 4 j k INDIFFERENCE CURVES What is Preferred

Slide 12: 

Quantity of A Quantity of B 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 An Indifference Schedule Combi- nation Units of A Units of B j 12 2 k 6 4 l 4 6 j k l INDIFFERENCE CURVES What is Preferred

Slide 13: 

Quantity of A Quantity of B 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 An Indifference Schedule Combi- nation Units of A Units of B j 12 2 k 6 4 l 4 6 m 3 8 j k l m INDIFFERENCE CURVES What is Preferred

Slide 14: 

Quantity of A Quantity of B 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 An Indifference Schedule Combi- nation Units of A Units of B j 12 2 k 6 4 l 4 6 m 3 8 j k l m I INDIFFERENCE CURVES What is Preferred

Slide 15: 

I2 Quantity of A Quantity of B 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 An Indifference Schedule Combi- nation Units of A Units of B j 12 2 k 6 4 l 4 6 m 3 8 j k l m The slope represents the marginal rate of substi- tution, (MRS) I1 INDIFFERENCE CURVES What is Preferred

Slide 16: 

Quantity of A Quantity of B 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 An Indifference Schedule Combi- nation Units of A Units of B j 12 2 k 6 4 l 4 6 m 3 8 I1 INDIFFERENCE CURVES What is Preferred

Slide 17: 

Quantity of A Quantity of B 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 An Indifference Schedule Combi- nation Units of A Units of B j 12 2 k 6 4 l 4 6 m 3 8 I1 I2 I3 I4 INDIFFERENCE CURVES What is Preferred

Slide 18: 

Quantity of A Quantity of B 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 An Indifference Schedule Combi- nation Units of A Units of B j 12 2 k 6 4 l 4 6 m 3 8 I1 I2 I3 I4 An Indifference Map INDIFFERENCE CURVES What is Preferred

Slide 19: 

EQUILIBRIUM AT TANGENCY I1 I2 Quantity of A Quantity of B I3 I4 (Attainable) (Unattainable) 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 An Indifference Schedule Combi- nation Units of A Units of B j 12 2 k 6 4 l 4 6 m 3 8

Slide 20: 

Quantity of A Quantity of B (Attainable) (Unattainable) Equilibrium occurs when the consumer selects the combination which reaches the highest attainable indifference curve. I1 I2 I3 I4 EQUILIBRIUM AT TANGENCY

Slide 21: 

What happens if the price of B increases to $1.50? PriceB QuantityB $1.00 6 I3 The budget line rotates reflecting the reduction in the quantity of B units which is attainable. Quantity of A Quantity of B EQUILIBRIUM AT TANGENCY

Slide 22: 

What happens if the price of B increases to $1.50? PriceB QuantityB $1.00 1.50 6 3 By recording the various quantities demanded at the various prices yields the Demand schedule I2 I3 The budget line rotates reflecting the reduction in the quantity of B units which is attainable. Quantity of A Quantity of B EQUILIBRIUM AT TANGENCY

Slide 23: 

What happens if the price of B increases to $1.50? PriceB QuantityB $1.00 1.50 6 3 By recording the various quantities demanded at the various prices yields the demand schedule. DERIVING THE DEMAND CURVE Price of B Quantity of B $1.50 1.00 0 2 4 6 8 10 12 DB Plotting the Points yields the Demand Curve for Product B

Marginal Utility Analysis : 

Another way of looking at the utility maximizing behavior of the individual consumer is through the use of marginal utility analysis. First, some definitions: Total Utility is the total amount of satisfaction derived from consuming a good or service. Marginal Utility is the additional utility derived from consuming one more unit of a good or service. Marginal Utility Analysis

The Law of Diminishing Marginal Utility : 

The Law of Diminishing Marginal Utility 12/18/2009 EC 201 As you consume more and more of any good or service over a specific time period the marginal utility derived will eventually fall. As successive units bring less and less satisfaction it is actually possible that Marginal Utility will eventually become negative. (I.e., the 20th taco over a one-half hour period!)

The Utility Maximizing Rule : 

The Utility Maximizing Rule 12/18/2009 EC 201 We have already stated that the consumer maximizes utility where the budget constraint and the indifference curves are tangent. Another way of stating this is that the slope of the budget constraint (the ratio of the price of good X to the price of good Y) should be equal to the slope of the indifference curve (the ratio of the marginal utility of good X to the marginal utility of good Y).

The Utility Maximizing Rule, cont. : 

The Utility Maximizing Rule, cont. 12/18/2009 EC 201 PX/PY = MUX/MUY Rearranging these terms you get the standard definition for the utility maximizing amount of any two goods or services that should be consumed: MUX / PX = MUY /PY Or, the consumer should allocate his income so that the marginal utility per dollar spent is the same for all goods.

Example : 

Example 12/18/2009 EC 201 Let’s say that you are consuming apples at a point where the marginal utility is equal to 50 and the price per pound is equal to $2.00. You also consume gasoline and the marginal utility of gas is equal to 30 and the price per gallon is $1.50. Are you maximizing your utility and if not what can you do to get to the utility maximizing point. Use both the algebra and a graph to fully explain your answer.

Indifference Curves and Marginal Utility : 

Indifference Curves and Marginal Utility One final point on the slope of the indifference curve. The ratio of the two marginal utilities is also called the marginal rate of substitution (MRS). The MRS is the rate at which a person will give up good Y in order to get more of good X and at the same time remain indifferent. Since the Indifference curve is convex, this indicates that there is a diminishing MRS (the slope of the indifference curve gets smaller as you move along it.)

Recap : 

Recap 12/18/2009 EC 201 Utility is maximized where the slope of the budget constraint is equal to the slope of the indifference curve. Utility is maximized where the price ratio is equal to the MRS Utility is maximized where the marginal utility per dollar spent is the same for all goods. There will always be a diminishing MRS. There will always be a diminishing marginal utility as additional units of a good are consumed.

Consumer and Producer Surplus : 

Consumer and Producer Surplus

Consumer Surplus : 

Consumer Surplus The difference between the price that a consumer is prepared to pay and the actual price paid Related to the value we place on items Linked to the degree of utility Useful concept in analysing welfare gains and losses as a result of resource allocation Emphasis on the MARKET demand – of those in the market there are some who are willing to pay higher prices than the market price

Consumer Surplus : 

Consumer Surplus Price (£) Quantity Demanded D = Marginal Utility 5 9 15 20 Market Price = £5 20 consumers willing to pay £5 15 Consumers WILLING to pay £9 These 15 consumers get 15 x £4 of consumer surplus Total utility = value represented by blue and gold area Blue area is amount paid to acquire good. Gold area = total consumer surplus

Producer Surplus : 

Producer Surplus Difference between the market price received by the seller and the price they would have been prepared to supply at Price received – linked to factor cost + element of normal profit Producer surplus = abnormal profit

Producer Surplus : 

Producer Surplus Price (£) Quantity Supplied S 10 60 Market price = £10 At £10, suppliers willing to offer 60 for sale Total Revenue = blue area £10 x 60 = £600 35 6 Some suppliers would have offered 35 for sale at £6: Producer surplus = 35 x £4 = £140 Gold area = Producer surplus

Slide 36: 

Key Terms budget line indifference curve marginal rate of substitution (MRS) indifference map equilibrium position