Consumer Preferences/Indifference

Curve
Indifference Curve.
 An indifference curve provides all the
combinations of a set of goods giving a
consumer the same level of satisfaction.
 Because more of each good is preferred to
less, we can compare market baskets in the
shaded areas. Basket A is clearly preferred to
basket G, while E is clearly preferred to A.
 However, A cannot be compared with B, D, or
H without additional information.
Basic Properties of Consumer Preference (1/2)

 Completeness
 Capability of expressing a preference for
or being indifferent.

 More is better
 Marginal rate of substitution.
 Maximum amount of a good that a
consumer is willing to give up in order
to obtain one additional unit of another
good.
Basic Properties of Consumer Preference (2/2)

 Diminishing marginal rate of substitution

 The decline in the MRS reflects a diminishing
marginal rate of substitution. When the MRS
diminishes along an indifference curve, the curve is
convex.
 Transitivity
 Avoid a perpetual cycle of “No” definite choice.
 If A>B and B>C, then A>C. Similarly, if A~B and
B~C, then A~C.
Indifference Map

 An indifference map is a set of indifference

curves that describes a person's preferences.
 Any market basket on indifference curve U3,
such as basket A, is preferred to any basket on
curve U2 (e.g., basket B), which in turn is
preferred to any basket on U1, such as D.
Marginal Rate of Substitution
 The magnitude of the slope of an indifference
curve measures the consumer’s marginal rate of
substitution (MRS) between two goods.
 Line AG (which passes through points B, D, and
E) shows the budget associated with an income of
$80, a price of food of PF = $1 per unit, and a price
of clothing of PC = $2 per unit.
 In this figure, the MRS between clothing (C) and
food (F) is 10 (between B and D).
 The slope of the budget line (measured between
points B and D) is −PF/PC = −10/20 = −1/2.
Consumer Equilibrium

 Affordability.
 The consumer has no incentive to change
to a different affordable bundle.
 Slope of indifference curve is equal to the
slope of budget line.
Movements in the Budget Line (Change in
Income)
Increase in income leads to rightward shift in
budget line and vice-versa.
Movements in the Budget Line (Change in
Price)
Decrease in price of X leads to more of X and
increase in price shifts budget line to the left
for X good.
Price Change and Consumer Behaviour

 Substitutes Good
 Increase in price of good, X.
 More of Y is consumed as X is a substitute of Y.

 Examples
 Want people to drink less? Make their cigarettes
more expensive?
Price Change and Consumer Behaviour

 Complement Good
Decrease in price of good, X.
 More of Y is consumed as X and Y are called
complement goods.
Income Change and Consumer Behaviour

 Normal Goods
 Increase in consumption.

 Inferior Goods
 If X is an inferior good, it is consumed less and
more of good Y is consumed.
Income Effect and Substitution Effect

 Increase in Price of Good X.

 Income Effect: Xm-XI

 Substitution Effects: X0-Xm
Individual Demand
Curve

Income Changes
 From indifference curve to individual demand
curve.
 An increase in income, with the prices of all
goods fixed, causes consumers to alter their
choice of market baskets.
 In part (a), the baskets that maximize
consumer satisfaction for various incomes (point
A, $10; B,
$20; D, $30) trace out the income-consumption
curve.
 The shift to the right of the demand curve in
response to the increases in income is shown in
part (b). (Points E, G, and H correspond to points
A, B, and D, respectively.)
From Individual Demand Curves to Market Demand Curve

 Horizontal Summation of Individual

Demand Curves.
Demand Curve

 Why?
 Diminishing Marginal Utility.
 Increase/Decrease in Real Income.

 Income Group?
 Demand Curves for Every Commodity
Slope Downward?
 Giffen Goods (Inferior Goods) and Veblon
Goods (Luxurious Goods)!
Market Demand
Market Demand Curve

 Summing our three consumers’ demand curves

DA, DB, and DC.
 At each price, the quantity demanded by the
market is the sum of the quantities demanded
by each consumer.
 For example, at a price of $4, the quantity
demanded by the market (11 units) is the sum
of the quantity demanded by A (no units), B (4
units), and C (7 units).
Change in Quantity
Demanded

 Movement along the demand curve:

 Following a change in the price of that good.
Change in Demand

 Shift of the Demand Curve:

 Following a change in any factor
influencing the demand other than price
of that good.
Change in Quantity
Supplied

 Change in quantity supplied of a good is a

movement along the supply curve following a
change in the price of that good.

 Movement along the curve!

 Producer
Surplus

 A change in the supply curve following a

change in any factor influencing the supply

other than price of that good.
Shift in