9/24

Consumer Theory
Where does the demand curve come from?
1. Preferences
a. Built-up through pair-wise comparisons. Given any 2 choices, Say A is preferred
to B, vice versa, both equally
2. Affordability
3. Rationality - any consumer makes the best choice

Ex. other classes- principles of econ, art hum, intro to cs

Ex. 20 cups of coffee, 15 sandwiches, 10 subway rides, 2 laundry trips

Assumption 1: More is preferred to less

Assumption 2: Completeness - given any 2 choices, A&B, either A is preferred to B, B>A, A=B
Assumption 3: Transitivity- If A>B and B>C, then A>C

Indifference Curves
What happens when you don’t care about certain choices? What other consumption choices are
just as good as A?
- Indifference Curve: depicts combinations that are just as good as A (a set of indifference
curves creates an indifference map)
Properties of ICs
1. Downward sloping
2. No two indifference curves may cross
3. Concave to the origin- IC becomes flatter with increase in x-variable (cups of coffee) and
less y-variable (sandwiches)

● Given an indifference curve map, we can associate numbers with utilities so that each IC
has a single number or utility
● Slope of indifference curve is the marginal rate of substitution (MRS) (keep the height
constant)
● The marginal utility of coffee is the slope of the utility function with respect to coffee
alone (keep sandwiches constant)
○ Same goes to sandwich (keep coffee constant)
● MRS = - MUC/MUS

9/27

CHAPTER 10 APPENDIX

1. Deriving demand curve from 3 factors

2. Examples (graphically, algebraically)
Consumer Theory (Part 2)
1. Preferences (covered last Friday)
2. Affordability
3. Rationality

Slope of indifference curve = MRS (Marginal rate of substitution)

- The slope of the tangent to the indifference curve is the MRS
- If the slope is 1, if you get a little more coffee, you will give up 1 sandwich (see p.5)

When do you have straight-line indifference curves?

- Constant relationship ($10 to $5)
- Perfect substitutes (almond and oat milk say)
When do you have a 90-degree indifference curve?
- 2 perfect complement goods (hotdogs and hotdog buns)

Affordability - what can you buy?

Suppose price of coffee is $4/cup and price of sandwiches is $6/sandwich
- Budget is $60

Affordable combinations are given by:

c = # of coffee, s = # of sandwiches
4c + 6s = 60
- This is the equation of a straight line (it would be the budget line on a graph) (p.5)
- We do an equal sign bc we assume more is better.
- Slope of the budget line is -4/6 or -⅔
**More generally, pCc + pSs = Y
- Slope = -pC/pS

Rationality
If the slope of the indifference curve at A is greater than the slope of the budget line, then
consume more coffee and less sandwiches.
- A is not the rational choice (p.6)
- Best/rational affordable choice is where the indifference curve is tangent to the budget
line

Algebraic example
U (utility) depends on the # of coffee and # of sandwiches
- Represented by U (c, s) = c1/2 s1/2
- Ex. if c = 16 and s=25, then U = 4x5 = 20

MRS = MUC/MUS = s/c

- x-variable divided by y-variable

Point B (on budget line) has two characteristics (p. 6)

 1. On the budget line
2. Tangency between budget line and indifference curve is at point B

1. says 4c+6s = 60
2. says s/c = 4/6

S = 4/6c
Substitute back into 1
4c+4c = 60
8c = 60
c = 7.5
So s = 5

General form of demand curve

= Y/2PC