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That is, at each point on the curve, the consumer has no preference for one bundle over another. One can equivalently refer to each point on the indifference curve as rendering the same level of utility (satisfaction) for the consumer. Utility is then a device to represent preferences rather than something from which preferences come.[1] The main use of indifference curves is in the representation of potentially observable demand patterns for individual consumers over commodity bundles.[2] There are infinitely many indifference curves: one passes through each combination. A collection of (selected) indifference curves, illustrated graphically, is referred to as an indifference map.

An example of an indifference map with three indifference curves represented

A graph of indifference curves for an individual consumer associated with different utility levels is called an indifference map. Points yielding different utility levels are each associated with distinct indifference curves and is like a contour line on a topographical map. Each point on the curve represents the same elevation. If you move "off" an indifference curve traveling in a northeast direction (assuming positive marginal utility for the goods) you are essentially climbing a mound of utility. The higher you go the greater the level of utility. The non-satiation requirement means that you will never reach the "top", or a "bliss point", a consumption bundle that is preferred to all others Indifference curves are typically represented to be:

1. Defined only in the non-negative quadrant of commodity quantities (i.e. the possibility of having negative quantities of any good is ignored). 2. Negatively sloped. That is, as quantity consumed of one good (X) increases, total satisfaction would increase if not offset by a decrease in the quantity consumed of the other good (Y). Equivalently, satiation, such that more of either good (or both) is equally preferred to no increase, is excluded. (If utility U = f(x, y), U, in the third dimension, does not have a local maximum for any x and y values.) The negative slope of the indifference curve reflects the law of

diminishing marginal utility. That is as more of a good is consumed total utility increases at a decreasing rate - additions to utility per unit consumption are successively smaller. Thus as you move down the indifference curve you are trading consumption of units of Y for additional units of X. 3. Complete, such that all points on an indifference curve are ranked equally preferred and ranked either more or less preferred than every other point not on the curve. So, with (2), no two curves can intersect (otherwise non-satiation would be violated). 4. Transitive with respect to points on distinct indifference curves. That is, if each point on I2 is (strictly) preferred to each point on I1, and each point on I3 is preferred to each point on I2, each point on I3 is preferred to each point on I1. A negative slope and transitivity exclude indifference curves crossing, since straight lines from the origin on both sides of where they crossed would give opposite and intransitive preference rankings. 5. (Strictly) convex. With (2), convex preferences imply that the indifference curves cannot be concave to the origin, i.e. they will either be straight lines or bulge toward the origin of the indifference curve. If the latter is the case, then as a consumer decreases consumption of one good in successive units, successively larger doses of the other good are required to keep satisfaction unchanged.

**[edit] Assumptions of consumer preference theory
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Preferences are complete o Assume that there are two consumption bundles A and B each containing two commodities x and y. A consumer can unambiguously determine that one and only one of the following is the case: A is preferred to B A p B[3] p [3] B is preferred to A B A A is indifferent to B A I B[3] Note that this axiom precludes the possibility that the consumer cannot decide,[4] and that a consumer is able to make this comparison with respect to every conceivable bundle of goods.[3] Preferences are reflexive o Means that if A and B are in all respect identical the consumer will recognize this fact and be indifferent in comparing A and B I [3] A=B A B [nb 1] Preference are transitive o If A p B and B p C then A p C.[3] I I I [3] o Also A B and B C then A C. This is a consistency assumption. Preferences are continuous o If A is preferred to B and C is infinitesimally close to B then A is preferred to C. o A p B & C B A p B. "Continuous" means infinitely divisible - just like there are an infinity of numbers between 1 and 2 all bundles are infinitely divisible. This assumption makes indifference curves continuous. Preferences exhibit strong monotonicity. o if A has more of both x and y than B then A is preferred to B this is assumption is commonly called the "more is better" assumption

First. Consumer theory uses indifference curves and budget constraints to generate consumer demand curves. Qy). Consumers are willing to give up or trade-off some of one good to get more of another.y y an alternative version of this assumption is strong monotonicity which requires that if A and B have the same quantity of one good. o The marginal rate of substitution tells how much y a person is willing to sacrifice to get one more unit of x. [edit] Application To maximise utility. a full demand schedule can be deduced as the price of one good fluctuates. o This assumption also set the stage for using techniques of constrained optimization. either xnot-pz or znot-py or both. if the market values a good . the household will sell it. o This is also called the substitution assumption. but A has more of the other then A is preferred to B Indifference curves exhibit diminishing marginal rates of substitution o This assumption assures that indifference curves are smooth and convex to the origin. This is the most critical assumption of consumer theory. This follows from common sense: if the market values a good more than the household. let one good be an example market e. this is a relatively simple process. Because the shape of the curve assures that the first derivative is negative and the second is positive. [6] There are also many sub-assumptions: o Irreflexivity . Budget constraints gives a straight line on the indifference map showing all the possible distributions between the two goods. Assuming it does. carrots. The fundamental assertion is that there is a maximum amount that "a consumer will give up of one commodity to get one unit of other good is that amount which will leave the consumer indifferent between the new and old situations"[6] The negative slope of the indifference curves represents the willingness of the consumer to make a trade off. a household should consume at (Qx. the point of maximum utility is then the point at which an indifference curve is tangent to the budget line (illustrated). For a single consumer.for no x is xpx o Negative transivity if xnot-py then for any third commodity z.g. and let the other be a composite of all other goods.

leading to a different point of tangency and a different quantity demanded. The gray line indifference map with three perpendicular to all curves indicates indifference curves the curves are mutually parallel. An example of the type of utility function that has an indifference map like that above is .[8] [edit] Examples of indifference curves Figure 2: Three indifference curves where Goods X and Y are perfect Figure 1: An example of an substitutes. the consumer seeks less the expensive substitute at a lower indifference curve. The elbows of the curves are collinear.are equally preferred. the household will buy it.less than the household. represented Figure 3: Indifference curves for perfect complements X and Y. if the price of carrots were to change. The substitution effect is reinforced through the income effect of lower real income (Beattie-LaFrance).however many . In Figure 1. As price rises for a fixed money income. An example of a utility function that is associated with indifference curves like these would be . so bundles of goods differing only in the number of right shoes they includes . These price / quantity combinations can then be used to deduce a full demand curve. . known by economists as the marginal rate of substitution. The process then continues until the market's and household's marginal rates of substitution are equal. The marginal rate of substitution is either zero or infinite. and the price of all other goods were to remain constant. describing the negative substitution effect. but does not care where he/she is on a given indifference curve. The marginal rate of substitution between perfect substitutes is likewise constant. shows the rate at which consumers are willing to give up one good in exchange for more of the other good. An example of a utility function that generates indifference curves of this kind is the Cobb-Douglas function .additional right shoes have zero marginal utility without more left shoes. The negative slope of the indifference curve incorporates the willingness of the consumer to means to make trade offs. the gradient of the budget line would also change. For most goods the marginal rate of substitution is not constant so their indifference curves are curved. If two goods are perfect complements then the indifference curves will be L-shaped.[7] Now. and would rather be on I2 than I1. The slope of an indifference curve (in absolute value). the consumer would rather be on I3 than I2. The curves are convex to the origin. Examples of perfect complements include left shoes compared to right shoes: the consumer is no better off having several right shoes if she has only one left shoe .[9] If two goods are perfect substitutes then the indifference curves will have a constant slope since the consumer would be willing to switch between at a fixed ratio.

' That is. The statement is at least as good as (in preference . [edit] Preference relations Let = a set of mutually exclusive alternatives among which a consumer can choose and = generic elements of . The results will only be stated here. A price-budget-line change that kept a consumer in equilibrium on the same indifference curve: in Fig. In the language of the example above.[nb 2] [edit] Preference relations and utility Choice theory formally represents consumers by a preference relation. The symbol is one such combination. 1 would reduce quantity demanded of a good smoothly as price rose relatively for that good. is described as ' is weakly preferred to . and use this representation to derive indifference curves showing combinations of equal preference to the consumer. A preference relation. 2 would have either no effect on quantity demanded of either good (at one end of the budget constraint) or would change quantity demanded from one end of the budget constraint to the other. in Fig. such as 1 apple and 4 bananas and is another combination such as 2 apples and 2 bananas. 3 would have no effect on equilibrium quantities demanded. satisfaction). in Fig.The different shapes of the curves imply different responses to a change in price as shown from demand analysis in consumer theory. since the budget line would rotate around the corner of the indifference curve. the set is made of combinations of apples and bananas. denoted The statement . is a binary relation define on the set .

the bundle is and take the total derivative of or. Denote the first element in this list by curve since . forms an indifference [edit] Formal link to utility theory In the example above. to . such as . . If .is described as ' is weakly preferred to . 1) . call it is made of two numbers: The number of apples. Only the ranking of those values has content for the theory. More precisely. . one is indifferent to the choice of or . meaning not that they are unwanted but that they are equally good in satisfying preferences. The set . The actual values of the function have no importance.' The preference relation relation if whenever is complete if all pairs and then can be ranked. the second by for all and so on. the utility function of an agent is a function that ranks all pairs of consumption bundles by order of preference (completeness) such that any set of three or more bundles forms a transitive relation. Suppose one builds the list of all other elements of which are indifferent. if described as at least as good as the bundle . This means that for each bundle there is a unique relation. The statement is described as ' is weakly preferred to .' One says that ' is strictly preferred to . in the eyes of the consumer.' That is. The relation representing the utility (satisfaction) relation associated with is called the utility function. In utility theory. an element of the set call it and the number of bananas. but is not weakly preferred to . then the bundle . Consider a particular element of the set .. The range of the function is a set of real numbers.. about this point: is described as strictly preferred to the bundle Consider a particular bundle . and is weakly preferred to . The relation is a transitive . (Eq. without loss of generality.

Therefore. 1) above to solve for dy/dx: . The slope of the indifference Observe that the slope does not depend on or : the indifference curves are straight lines. therefore. That is. then the marginal utility of is .Where < 1. the ratio of marginal utilities gives the absolute value of the slope of the indifference curve at point [edit] Examples [edit] Linear utility . if one is to change the quantity of by . the indifference curves are the level curves of the utility function. If the utility function is of the form and the marginal utility of is curve is. Thus. This ratio is called the marginal rate of substitution between and . (Likewise for ) with respect to its first argument. The slope of the indifference curve. without moving off the indifference curve. there is no change in U: . when preferences are represented by a utility function. and therefore the negative of the marginal rate of substitution. in the end. substituting 0 into (Eq. one must also change the quantity of by an amount such that.where at is the partial derivative of . [edit] Cobb-Douglas utility If the utility function is of the form the marginal utility of is and the marginal utility of is . or. is then . evaluated The indifference curve through must deliver at each bundle on the curve the same utility level as bundle .

Assumptions of consumer preference theory y Preferences are complete - y o Assume that there are two consumption bundles A and B each containing two commodities x and y. (The Cobb-Douglas is a special case of the CES utility. These examples might be useful for modelling individual or aggregate demand. with .[edit] CES utility A general CES (Constant Elasticity of Substitution) form is where and . A consumer can unambiguously make the following comparisons: y o A is preferred to B A p B B is preferred to A B p A A is indifferent to B A I B .) The marginal utilities are given by and Therefore. along an indifference curve.

Note this assumption means that a consumer is able to make this comparison with respect to every conceivable bundle of goods. y Preferences exhibit non-satiation. A p B & C B A p B. This assumption allows the use of curves and areas all the basic requirements of differential and integral calculus.just like there are an infinity of numbers between 1 and 2 all bundles are infinitely divisible. y Preferences are reflexive o Means that if A and B are in all respect identical the consumer will recognize this fact and be indifferent in comparing A and B A=B AIB y Preference are transitive y o o If A p B and B p C then A p C. Note that this axiom precludes the possibility that the consumer cannot decide. o if A and B have identical amounts of x and A has a little more y than B then A is preferred to B. This is a consistency assumption. this is the more is better assumption . "continuous" means infinitely divisible . y Preferences are continuous y o o If A is preferred to B and C is infinitesimally close to B then A is preferred to C. Indifference allowed indecision not. I can't make up my mind. Also A I B and B I C then A I C.

resulting in an. o The MRS tells how much y a person is willing to sacrifice to get one more unit of x. It concludes that in a competitive market. o This assumption also set the stage for using techniques of constrained optimization.for no x is xpx negative transivity if xpy then for any third commodity z. o This is also called the substitution assumption. . uses indifference curves and budget constraints to generate consumer demand curves Supply and demand Supply and demand is an economic model of price determination in a market. the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers .y Indifference Curves exhibit diminishing marginal rates of substitution o This assumption assures that indifference curves are smooth and convex to the origin. Consumers are willing to give up or trade-off some of one good to get more of another. Because the shape of the curve assures that the first derivative is negative and the second is positive. either xpz or zpy or both. and the demand curve is one of the most complex relations in economics... This is the most critical assumption of consumer theory. The fundamental assertion is that there is a maximum amount that "a consumer will give up of one commodity to get one unit of other good is that amount which will leave the consumer indifferent between the new and old situations" The negative slope of the indifference curves represents the willingness of the consumer to make a trade off.. The link between personal preferences. consumption. Application y Consumer theory Consumer theory Consumer choice is a theory of microeconomics that relates preferences to consumer demand curves.. . y y y There are also many sub-assumptions: Irreflexivity .

. describing the negative substitution effect.. there will be a new budget constraint line that intersects a higher indifference curve. An example of a utility function that is associated with indifference curves like these would be .With a higher income. The curves are convex to the origin. An example of a utility function that generates indifference curves of this kind is the Cobb-Douglas function . The negative slope of the indifference curve incorporates the willingness of the consumer to means to make trade offs.. . the demand for a good is decreased when the price of another good is decreased. . As price rises for a fixed money income. the marginal rate of substitution is the rate at which a consumer is ready to give up one good in exchange for another good while maintaining the same level of satisfaction.This means a good's demand is increased when the price of another good is increased.. and would rather be on I2 than I1. is a good with a positive cross elasticity of demand.-Marginal rate of substitution as the slope of indifference curve:. The substitution effect is reinforced through the income effect Income effect In economics... of lower real income (Beattie-LaFrance). Conversely. but does not care where he/she is on a given indifference curve. the consumer would rather be on I3 than I2. shows the rate at which consumers are willing to give up one good in exchange for more of the other good. If two goods are perfect substitutes Substitute good . The slope of an indifference curve (in absolute value). the income effect is the change in consumption resulting from a change in real income.A substitute good. then the indifference curves will have a constant slope since the consumer would be willing to trade at a fixed ratio. The marginal rate of substitution between perfect substitutes is likewise constant. the consumer seeks less the expensive substitute at a lower indifference curve. For most goods the marginal rate of substitution is not constant so their indifference curves are curved. in contrast to a complementary good.Examples of indifference curves In Figure 1. known by economists as the marginal rate of substitution Marginal rate of substitution In economics.

. The consumer is no better off having several right shoes if she has only one left shoe.. in Fig. The results will only be stated here. is a good with a negative cross elasticity of demand. The link between personal preferences. .A complementary good. Another example of perfect complements is a left shoe and a right shoe. The marginal rate of substitution is either zero or infinite. 3 would have no effect on equilibrium quantities demanded. and the demand curve is one of the most complex relations in economics. No matter how much extra flour you had. then the indifference curves will be L-shaped. Conversely.. consumption. An example of the type of utility function that has an indifference map like that above is . 1 would reduce quantity demanded of a good smoothly as price rose relatively for that good. in Fig. since the budget line would rotate around the corner of the indifference curve. 2 would have either no effect on quantity demanded of either good (at one end of the budget constraint) or would change quantity demanded from one end of the budget constraint to the other.. . An example would be something like if you had a cookie recipe that called for 3 cups flour to 1 cup sugar. This means a good's demand is increased when the price of another good is decreased. in contrast to a substitute good. Additional right shoes have zero marginal utility without more left shoes.If two goods are perfect complements Complement good . A price-budget-line change that kept a consumer in equilibrium on the same indifference curve: in Fig. The different shapes of the curves imply different responses to a change in price as shown from demand analysis in consumer theory Consumer theory Consumer choice is a theory of microeconomics that relates preferences to consumer demand curves. the demand for a good is decreased when the price of another good is increased. you still could not make more cookie dough without more sugar.

Preference relations Let = a set of mutually exclusive alternatives among which a consumer can choose and = generic elements of . . is at least as good as (in preference satisfaction). The idea of an indifference curve is a straightforward one: If a consumer was equally satisfied with 1 apple and 4 bananas. a binary relation between two sets A and B is a subset of. such as 1 apple and 4 bananas and is another combination such as 2 apples and 2 bananas.' That is. The symbol is one such combination.. it is a subset of the Cartesian product A2 = . is a binary relation Binary relation In mathematics. A preference relation. The statement is described as ' is weakly preferred to . and is weakly preferred to . 2 apples and 2 bananas. More generally. Often curves in two-dimensional or three-dimensional Euclidean space are of interest.' That is. generally speaking. and use this representation to derive indifference curves. or 5 apples and 1 banana. a binary relation on a set A is a collection of ordered pairs of elements of A. these combinations would all lie on the same indifference curve Curve In mathematics. In other words. define on the set . one is indifferent to the choice of or . meaning not that they are unwanted but that they are equally good in satisfying preferences. denoted .Preference relations and utility Choice theory formally represents consumers by a preference relation. . an object similar to a line but which is not required to be straight.. In the language of the example above. The statement is described as ' is weakly preferred to ... a curve is. the set is made of combinations of apples and bananas..

to .. Denote the first element in this list by . then a is also related to c.. Consider a particular element of the set . .... . then a is also related to c. the second by and so on. a binary relation R over a set X is transitive if whenever an element a is related to an element b. the utility function of an agent is a function that ranks all pairs of consumption bundles by order of preference (completeness) such that any set of three or more bundles forms a transitive relation Transitive relation In mathematics. such as . in the eyes of the consumer. a binary relation R over a set X is transitive if whenever an element a is related to an element b.. theory. Suppose one builds the list of all other elements of which are indifferent. representing the utility .' One says that ' is strictly preferred to .The statement is described as ' is weakly preferred to .. The relation is a transitive relation Transitive relation In mathematics. and b is in turn related to an element c. an element of the set is made of two numbers: The number of apples.. if whenever and then .. This means that for each bundle there is a unique relation. Formal link to utility theory In the example above. one may speak meaningfully of increasing or decreasing utility.' The preference relation is complete if all pairs can be ranked. but is not weakly preferred to . utility is a measure of relative satisfaction. Given this measure.. call it and the number of bananas. The set forms an indifference curve since for all . and thereby explain economic behavior in terms of attempts to increase one's utility. and b is in turn related to an element c. call it In utility Utility In economics.

if one is to change the quantity of by .. Thus. incline. of the indifference curve at point . without moving off the indifference curve. Therefore. without loss of generality.. Only the ranking of those values has content for the theory. there is no change in U:. the slope or gradient of a line describes its steepness.. The range Range (mathematics) In mathematics. That is. the bundle is described as strictly preferred to the bundle . More precisely. the range of a function refers to the output of a function. or grade. or. in the end. (Eq. utility is a measure of relative satisfaction. the ratio of marginal utilities gives the absolute value of the slope Slope In mathematics. Consider a particular bundle and take the total derivative of about this point: or. 1) where is the partial derivative of with respect to its first argument.. 1) above to solve for dy/dx:. and thereby explain economic behavior in terms of attempts to increase one's utility. (satisfaction) relation associated with . evaluated at . This disagreement among mathematicans is illustrated by the function f with f =. substituting 0 into (Eq. Given this measure. This ratio is called the marginal rate of substitution Marginal rate of substitution . then the bundle is described as at least as good as the bundle . but there is not universal agreement on the subject of whether the output is the range or is included in the range. one must also change the quantity of by an amount such that. of the function is a set of real numbers. the indifference curves are the level curves of the utility function. The actual values of the function have no importance.Utility In economics.. If . The relation is called the utility function. if . one may speak meaningfully of increasing or decreasing utility. when preferences are represented by a utility function. A higher slope value indicates a steeper incline... (Likewise for ) The indifference curve through must deliver at each bundle on the curve the same utility level as bundle .

the Cobb Douglas functional form of production functions is widely used to represent the relationship of an output to inputs. is then CES utility A general CES (Constant Elasticity of Substitution ) form is where and . utility If the utility function is of the form the marginal utility of is and the marginal utility of is .For production.Where .. therefore. of the indifference curve... Linear utility If the utility function is of the form then the marginal utility of is and the marginal utility of is .. and therefore the negative of the marginal rate of substitution .. Cobb-Douglas Cobb-Douglas In economics. the slope or gradient of a line describes its steepness... or grade. between and . It was proposed by Knut Wicksell . the function iswhere:*. The slope of the indifference curve is. (The Cobb-Douglas Cobb-Douglas . The slope Slope In mathematics. and tested against statistical evidence by Charles Cobb and Paul Douglas in 1900 1928.-Marginal rate of substitution as the slope of indifference curve:. the marginal rate of substitution is the rate at which a consumer is ready to give up one good in exchange for another good while maintaining the same level of satisfaction. incline. Observe that the slope does not depend on or : Indifference curves are straight lines.In economics. A higher slope value indicates a steeper incline.

The aim of indifference curve analysis is to analyse how a rational consumer chooses between two goods. In other words. as they would if they consumed 7 hours of work and 3 hours of leisure. how the change in the wage rate will affect the choice between leisure time and work time. the function iswhere:*. In other words. the Cobb Douglas functional form of production functions is widely used to represent the relationship of an output to inputs. is a special case of the CES utility. These examples might be useful for modelling individual or aggregate demand. it is a line that shows the consumption of different combinations of two goods that will give the same utility (satisfaction) to the person. Indifference analysis combines two concepts.. For instance. with . in Figure 1 the indifference curve is I1. It was proposed by Knut Wicksell .) The marginal utilities are given by and Therefore. Figure 1: An indifference curve for work and leisure .. A person would receive the same utility (satisfaction) from consuming 4 hours of work and 6 hours of leisure. indifference curves and budget lines (constraints) The indifference curve An indifference curve is a line that shows all the possible combinations of two goods between which a person is indifferent. and tested against statistical evidence by Charles Cobb and Paul Douglas in 1900 1928. along an indifference curve.For production.In economics.

This is due to the concept of the diminishing marginal rate of substitution between the two goods. then additional units will provide less additional satisfaction than the previous units.e.An important point is to remember that the use of an indifference curve does not try to put a physical measure onto how much utility a person receives. It is conventional to draw the curve as bowed. The reason why the marginal rate of substitution diminishes is due to the principle of diminishing marginal utility.e. Where this principle states that the more units of a good are consumed. work) then they will receive diminishing utility for that extra unit (satisfaction). . work) that has to be given up if the consumer is to obtain one extra unit of the other good (leisure). The equation is below The marginal rate of substitution (MRS) = change in good X / change in good Y Using Figure 1. Therefore. hence. as a person consumes more of one good (i. MRS = -3 / 3 = -1 = 1 Note. the marginal rate of substitution between point A and Point B is. the convention is to ignore the sign. The marginal rate of substitution is the amount of one good (i. The shape of the indifference curve Figure 1 highlights that the shape of the indifference curve is not a straight line. they will be willing to give up less of their leisure to obtain one more unit of work.

£2 per unit of x and £1 per unit of y. This discussion outlines the construction of a budget line and how the change in the determinants will affect the budget line. The budget line illustrates all the possible combinations of two goods that can be purchased at given prices and for a given consumer budget. If this occurs then it is termed an indifference curve map (Figure 2). while curves to the left (I2 and I1) show combinations that yield lower levels of utility. Figure 2: An indifference map The general rule is that indifference curves further too the right (I4 and I5) show combinations of the two goods that yield a higher utility. MRS = Mux / Muy It is possible to draw more than one indifference curve on the same diagram. A Budget Line (budget constraints) The budget line is an important component when analysing consumer behaviour.The relationship between marginal utility and the marginal rate of substitution is often summarised with the following equation. that the amount of a good that a person can buy will depend upon their income and the price of the good. . Figure 3 constructs a budget line for a given budget of £60. Remember.

therefore. This is illustrated in Figure 4. Figure 4: An increase in consumer income .With a limited budget the consumer can only consume a limited combination of x and y (the maximum combinations are on the actual budget line). Note that the prices of the two goods have remained the same. Hence an increase in consumer income will result in a shift in the budget line. Assume consumer income increased to £90. A change in consumer income and the budget line If consumer income increases then the consumer will be able to purchase higher combinations of goods. the increase in income will result in a parallel shift in the budget line.

The optimum consumption point is illustrated on Figure 6. A change in the price of a good and the budget line If income is held constant. Figure 5: A change in price The reduction of the price of good x from £2 to £1 means that on a fixed budget of £60. In other words.If consumer income fell then there would be a corresponding parallel shift to the left to represent a fall in the potential combinations of the two goods that can be purchased. hence the maximum point for good y will remain fixed. This is illustrated in Figure 5. the consumer could purchase a maximum of 60 units. indifference curves and budget lines (constraints) The first stage is to impose the indifference curve and the budget line to identify the consumption point between two goods that a rational consumer with a given budget would purchase. as opposed to 30. Figure 6: The optimum consumption point . and the price of one of the goods changes then the slope of the curve will change. Note that the price of good y has remained fixed. the curve will pivot. Indifference analysis combines two concepts.

If we assume that the good is normal. This point occurs where the indifference curve touches (is tangential to) the budget line. the income effect (have a limited budget. This is for two reasons. These two processes can be visualised using indifference analysis (see Figure 7). In the case of Figure 6. the optimum consumption point occurs at point A on indifference curve I3. Figure 7: An increase in the price of good x (a normal good) . then the increase in price will result in a fall in the quantity demanded. Indifference analysis can be used to analyse how a consumer would change the combination of two goods for a given change in their income or the price of the good. maximising consumer would prefer to be on the highest possible indifference curve given their budget constraint. The next section looks at the income and substitution effects of a change in price.A rational. therefore can purchase lower quantities of the good) and the substitution effect (swap with alternative goods that are cheaper).

The substitution effect y The substitution effect is when the consumer switches consumption patterns due to the price change alone but remains on the same indifference curve. the income and substitution effects work to reinforce each other. Therefore. The income effect y The income effect highlights how consumption will change due to the consumer having a change in purchasing power as a result of the price change. To identify the substitution effect a new budget line needs to be constructed. Therefore.Due to the price of good x increasing. in the case of a normal good. The budget line B1* is added. . The higher price means the budget line is B2. This point is on a lower indifference curve (I2). The decrease in the quantity demanded can be divided into two effects. the movement from Q1 to Q2 is purely due to the substitution effect. this budget line needs to be parallel with the budget line B2 and tangential to I1. hence the optimum consumption point is Q3. the budget line has pivoted from B1 to B2 and the consumption point has moved.

In microeconomics. but about all (other) existing possibilities. Non-satiation: This is the idea that people always want more --. or 5 apples and 1 banana. if a consumer was equally satisfied with 1 apple and 4 bananas. these combinations would all lie on the same indifference curve. Indifference Curve Properties Indifference curves are typically assumed to have the following features: y y Indifference curves do not cross. Assumptions These properties follow mathematically from the first three of the following list of assumptions. it has no preference for one over the other. many indifference curves can be drawn. which are troublesome. which is a consequence of the assumption that as consumers have less and less of one good. and (2) infinite knowledge about the set of factors which affect the personal satisfaction inherent in the option. and how much they would cost (including all implicit costs not reflected in the price). This is a consequence of the assumption that consumers will always prefer to have more of either good than to have less. For a given pair of goods. Non-satiation is frequently relaxed when the specifics of the market show that this is the case. The theory was developed so that analysis of economic choices could be based upon preferences. Transitivity: Essentially. . This is thus subject to another selection problem: the total utility of a given choice depends on how many tangible and intangible factors one takes into account. The curves are convex. The consumer is generally assumed to prefer combinations of goods representing higher levels of consumption. The theory of indifference curves was developed by Vilfredo Pareto and others in the first part of the 20th century. that is. These assumptions. For example. they require more of the other good to compensate (corresponding to the law of diminishing marginal utility. are made in conceiving of indifference curves and demand functions: Completeness: This assumption rests on the assertions that choice-makers have (1) infinite knowledge not just about the details of any apparent options. 2 apples and 2 bananas. They are used to analyse the choices of economic agents.not of something. All these (thoroughly impossible) conditions would together mean that every pair of options has a unique ordering of utility. which can be observed. an indifference curve is a graph showing combinations of two goods to which an economic agent (such as a consumer or firm) is indifferent. or what the alternatives might have been. who or what was destroyed by its production. the current utility is not even theoretically assessable. The rational consumer will make choices between the two goods to reach the highest indifference curve feasible given the choices available to her. this says the pair ordering above extends to more than two options and is unique. rather than the older concept of utility which suffers from the disadvantage that it cannot be objectively measured. but of everything and anything! This has elsewhere been called the philosophy of the cancer cell. Does one want to know how a commodity was made. given that such knowledge will likely affect the object's desirability (utility)? Since not buying something but rather waiting for a future alternative (which might radically change the attractiveness of existing options) is always one option.

Independence of budget and desires: It is assumed that consumers do not have control over the amount of their income. The curves are convex to the origin indicating a diminishing marginal rate of substitution. due to marketing). and to emphasize work which does not earn monetary compensation when they have enough. known by economists as the marginal rate of substitution. you still could not reach a higher cookie level if there was not enough sugar. and impulse as well. If the goods are perfect substitutes then the indifference curves will be parallel lines since the consumer would be willing to trade at a fixed ratio. one is not very happy with even more (but. An example would be something like if you had a cookie recipe that called for 3 cups flour to 1 cup sugar. The consumer is no better off having several right shoes if she has only one left shoe. This "irrationality" applies to mass behaviour (subject to "fashion") even more than it does to individuals. The marginal rate of substitution is either zero or infinite. The slope of an indifference curve. This is the assumption that a consumer not only can order options according to preference. and thus do not have a "budget line" for most decisions.i. No matter how much extra flour you had. the rational choice theory cannot be repaired with any perturbation. primarily out of habit or subject to an influence like "training" (e. Robotic behaviour: This seems separate from the other "rationality" criteria above. Additional right shoes have zero marginal utility without more left shoes. In reality. it is simply inapplicable. and would rather be on I2 than I1. but rather on habit. Consumers do not make their purchase decisions all at once. . Example Indifference Curves Below is an example of three indifference curves: The consumer would rather be on I3 than I2. but acts on such a utilitybased rationale rather than. Note however that a preference based on habit. Another example of perfect complements is a left shoe and a right shoe. many people are in a position to earn extra income when they need to purchase something big. humans are social beings and thus use heuristics such as morality and social influence to make these decisions. but does not care where they are on each indifference curve. This is also called convexity. since the given formalism is used to represent money-transactions only --.g. In other words. in contradiction to what any psychologist or advertising agent knows. The marginal rate of substitution is constant. in the context of a market --.there is an assumption that a consumer's set of choices which concern monetary costs is entirely independent from the set of choices which do not have any cost involved. still a little). If the goods are perfect complements then the indifference curves will be angled. shows the rate at which consumers are willing to give up one good in exchange for more of the other good. according to the previous assumption. For most goods the marginal rate of substitution is not constant so their indifference curves are curved.e.Satiation: The marginal value a person gets from each commodity falls with the number of units. Instead. bias or fashion does not necessarily contradict the theory. In reality. say. bias. the relationship between "utility" and effective "preference" is quietly assumed. people making choices are well aware that they are not acting on the sum of their knowledge. Independence of purchase choices from non-monetary choices: More generally. If one has much of something. If this is true.

.1 Indifference Map For a given pair of goods. See also continuous function in mathematics. They know either that X is preferred to Y. Indifference curves do not intersect. The rational consumer is expected to prefer the higher or right most Indifference curve. Rationality: Consumers know their individual preferences and can choose between consumption bundle X and consumption bundle Y. y y y 2. In other word. I am not confined to drinking 2 liters or nothing.2 Indifference Curve Properties Indifference curves are typically assumed to have the following features: y An Indifference curve slopes downward from left to right (negative slope). which is necessary to maintain the total satisfaction. Transitivity: If a consumer prefers bundle X to bundle Y. Consistency: If a consumer chooses bundle X to bundle Y in the first instance. For example. the next two are convenient. many indifference curves can be drawn and placed next to each other. or 12 mL. or that they are indifferent between X and Y. Y is preferred to X. This is a consequence of the assumption that consumers will always prefer to have more of either good than to have less. they require more of the other good to compensate (corresponding to the law of diminishing marginal utility). I could drink 11 mL of soda. The Indifference curves are ubiquitous throughout an indifference map. The curves are convex. 3 Assumptions The first three assumptions are necessary. The negative slope is a consequence of the fact that the demand for one commodity (X) increases while the demand for another commodity (Y) decreases (because of diminishing marginal utility of Y). and prefers bundle Y to bundle Z. then he must prefer bundle X to bundle Z. which is a consequence of the assumption that as consumers have less and less of one good. then he cannot choose bundle Y to bundle X in the second instance. there exists an indifference curve through any given point on an indifference map. Non-satiation: This is the idea that more of any good is always preferred to less. since they represent combinations of goods providing higher levels of consumption. or 132 mL. Continuity: This means that you can choose to consume any amount of the good. This representation is called an Indifference Map.

and would rather be on I2 than I1. but does not care where they are on each indifference curve. In a two good world. Additional right shoes have zero marginal utility without more left shoes. 4 Example Indifference Curves Below is an example of an indifference map having three indifference curves: The consumer would rather be on I3 than I2. if a consumer has relatively lots of one good he would be a happier with a little less of that good and a little more of the other. No matter how much extra flour you had. The marginal rate of substitution is either zero or infinite. . known by economists as the marginal rate of substitution. If the goods are perfect complements then the indifference curves will be L-shaped. For most goods the marginal rate of substitution is not constant so their indifference curves are curved.Convexity: The marginal value a person gets from each commodity falls relative to the other good. The curves are convex to the origin indicating a diminishing marginal rate of substitution. If the goods are perfect substitutes then the indifference curves will be parallel lines since the consumer would be willing to trade at a fixed ratio. The marginal rate of substitution is constant. The slope of an indifference curve. The consumer is no better off having several right shoes if she has only one left shoe. An example would be something like if you had a cookie recipe that called for 3 cups flour to 1 cup sugar. shows the rate at which consumers are willing to give up one good in exchange for more of the other good. Another example of perfect complements is a left shoe and a right shoe. you still could not make more cookie dough without more sugar.

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