INDIFFERENCE CURVE AND

UTILITY ANALYSES
INDIFFERENCE CURVE
ANALYSIS
Consumers Preferences
Assume Only Two Goods Sprite and Coke

A B C

5 Cokes 3 2 Cokes 6 4 Cokes 4

Sprite Sprites Sprites

2nd Choice 1st Choice 2nd Choice

Assumptions
1. Individual can rank their preference:
B preferred to A and C. A and C indifferent.
2. Non Satiation:
Individuals are better off if they have more.
D = 5 cokes + 7 sprites
D preferred to B
3. Transitivity:
 If D is preferred to B

and B is preferred to A and C

then D is preferred to A and C
4. Individuals are willing to give up successively smaller amounts of one
good in order to get additional units of other goods.
How to Draw
Key Concepts
• Indifference Curves are downward sloping,
• Convex and do not intersect,
• Higher indifference curve reflects greater level of
satisfaction,
• Slope is called Marginal Rate of Substitution
• Convex curve means declining marginal rate of
substitution
Declining Marginal Rate of Substitution
 INDIFFERENCE CURVES
What is Preferred
Units of Units of
A Price B Price Total j
$1.50 $1.00 Expenditures
12
8 0 $12
10
6 3 12
4 6 12 8

Quantity of A
2 9 12 6
0 12 12
An Indifference 4
Schedule
Combi- Units Units
nation of A of B 2
j 12 2
0
2 4 6 8 10 12
Quantity of B
 INDIFFERENCE CURVES
What is Preferred
Units of Units of
A Price B Price Total j
$1.50 $1.00 Expenditures
12
8 0 $12
10
6 3 12
4 6 12 8

Quantity of A
2 9 12 k
6
0 12 12
An Indifference 4
Schedule
Combi- Units Units
nation of A of B 2
j 12 2
0
k 6 4 2 4 6 8 10 12
Quantity of B
 INDIFFERENCE CURVES
What is Preferred
Units of Units of
A Price B Price Total j
$1.50 $1.00 Expenditures
12
8 0 $12
10
6 3 12
4 6 12 8

Quantity of A
2 9 12 k
6
0 12 12 l
An Indifference 4
Schedule
Combi- Units Units
nation of A of B 2
j 12 2
0
k 6 4 2 4 6 8 10 12
l 4 6 Quantity of B
 INDIFFERENCE CURVES
What is Preferred
Units of Units of
A Price B Price Total j
$1.50 $1.00 Expenditures
12
8 0 $12
10
6 3 12
4 6 12 8

Quantity of A
2 9 12 k
6
0 12 12 l
An Indifference 4
Schedule
m
Combi- Units Units
nation of A of B 2
j 12 2
0
k 6 4 2 4 6 8 10 12
l 4 6 Quantity of B
m 3 8
 INDIFFERENCE CURVES
What is Preferred
Units of Units of
A Price B Price Total j
$1.50 $1.00 Expenditures
12
8 0 $12
10
6 3 12
4 6 12 8

Quantity of A
2 9 12 k
6
0 12 12 l
An Indifference 4
Schedule
m
Combi- Units Units
nation of A of B 2 I
j 12 2
0
k 6 4 2 4 6 8 10 12
l 4 6 Quantity of B
m 3 8
 INDIFFERENCE CURVES
What is Preferred
Units of Units of
A Price B Price Total j The slope
$1.50 $1.00 Expenditures
12
represents
8 0 $12
10 the marginal
6 3 12 rate of substi-
4 6 12 8
tution, (MRS)

Quantity of A
2 9 12 k
6
0 12 12 l
An Indifference 4
Schedule
m
Combi- Units Units
nation of A of B 2 I2
I1
j 12 2
0
k 6 4 2 4 6 8 10 12
l 4 6 Quantity of B
m 3 8
 INDIFFERENCE CURVES
When Income Changes
Units of Units of
A Price B Price Total
$1.50 $1.00 Expenditures
12
8 0 $12
10
6 3 12
4 6 12 8

Quantity of A
2 9 12 6
0 12 12
An Indifference 4
Schedule
Combi- Units Units
nation of A of B 2
I1
j 12 2
0
k 6 4 2 4 6 8 10 12
l 4 6 Quantity of B
m 3 8
 INDIFFERENCE CURVES
A higher combination is Preferred
Units of Units of
A Price B Price Total
$1.50 $1.00 Expenditures
12
8 0 $12
10
6 3 12
4 6 12 8

Quantity of A
2 9 12 6
0 12 12
An Indifference 4 I4
Schedule I3
Combi- Units Units
nation of A of B 2 I2
I1
j 12 2
0
k 6 4 2 4 6 8 10 12
l 4 6 Quantity of B
m 3 8
 INDIFFERENCE CURVES
A family of Curves is a Map
Units of Units of
A Price B Price Total
$1.50 $1.00 Expenditures
12
8 0 $12
6 3 12
10 An
4 6 12 8 Indifference

Quantity of A
2 9 12 Map
6
0 12 12
An Indifference 4 I4
Schedule I3
Combi- Units Units
nation of A of B 2 I2
I1
j 12 2
0
k 6 4 2 4 6 8 10 12
l 4 6 Quantity of B
m 3 8
THE BUDGET LINE:
What is Attainable
Units of Units of Total
A Price B Price Expenditures
$1.50
$1.00 12
8 0 $12 10
6 3 12

Quantity of A
4 6 12 8
2 9 12 6
0 12 12
4

0 2 4 6 8 10 12
Quantity of B
 THE BUDGET LINE:
Units of
What is Attainable
Units of
A Price B Price Total
$1.50 $1.00 Expenditures
12
8 0 $12
6 3 12 10
4 6 12
2 9 12 8 (Unattainable)

Quantity of A
0 12 12
6

2 (Attainable)
0
2 4 6 8 10 12
Quantity of B
 INDIFFERENCE CURVES
A higher combination is Preferred
Units of Units of
A Price B Price Total
$1.50 $1.00 Expenditures
12
8 0 $12
10
6 3 12
4 6 12 8

Quantity of A
2 9 12 6
0 12 12
An Indifference 4 I4
Schedule I3
Combi- Units Units
nation of A of B 2 I2
I1
j 12 2
0
k 6 4 2 4 6 8 10 12
l 4 6 Quantity of B
m 3 8
Key Concepts
 The utility maximizing point occurs where the highest
indifference curve is tangent to the budget
constraint
 At the utility-maximizing point, the rate that
products must be traded in the market is just equal
to the rate at which the individual is willing to
substitute one good for the other.
Price Changes and Utility Maximization
A higher combination is Preferred
Units of Units of
A Price B Price Total
$1.50 $1.00 Expenditures
12
8 0 $12
10
6 3 12
4 6 12 8

Quantity of A
2 9 12 6
0 12 12
An Indifference 4 I4
Schedule I3
Combi- Units Units
nation of A of B 2 I2
I1
j 12 2
0
k 6 4 2 4 6 8 10 12
l 4 6 Quantity of B
m 3 8
Changes in Demand
Units of Units of
A Price B Price Total
$1.50 $1.00 Expenditures
12
8 0 $12
10
6 3 12
4 6 12 8

Quantity of A
2 9 12 6
0 12 12
An Indifference 4 I4
Schedule I3
Combi- Units Units
nation of A of B 2 I2
I1
j 12 2
0
k 6 4 2 4 6 8 10 12
l 4 6 Quantity of B
m 3 8
UTILITY THEORY
 Utility Theory
24

 What is Utility
 The want-satisfying power of a good or service

 Utility Analysis
 The analysis of consumer decision making based on utility
maximization

 Util
 A representative unit by which utility is measured

Chapter 21 - Consumer Choice

Assumptions of utility analysis
1. Cardinal Measurement: Satisfaction can be measured.
Numbers can be assigned to measure satisfaction.
2. Independent: Utility of one commodity is independent
of other.
3. Constant Marginal Utility of Money: Marginal utility of
money remains constant. More and more money you
get you will not be less and less satisfied.
4. From one’s own experience it is possible to guess
satisfaction level of another person.
 Utility Theory
26

 Marginal Utility
 Definition:The change in total utility due to a one-unit
change in the quantity of a good or service consumed is
called marginal utility.

Change in total utility

Marginal utility =
Change in number of units consumed

Chapter 21 - Consumer Choice

Some Maths
 U = f(Q)
 dU/dQ = marginal utility
 Suppose U = a + bQ + cQ2
 How to maximize utility
 du/dQ = b+2cQ
 And setting it to zero
 b+2cQ = 0
 Q= -b/2c
 When Q is equal to -b/2c then it is maximum
 Second derivative has to be negative
 Graphical Analysis
28

 We can appreciate total and marginal utility by

using graphical analysis.

Chapter 21 - Consumer Choice

Total and Marginal Utility
of Downloading and Listening to Digital Music
29

Albums

Chapter 21 - Consumer Choice

Total and Marginal Utility
of Downloading and Listening to Digital
Music Albums
30

Chapter 21 - Consumer Choice

Total and Marginal Utility
of Downloading and Listening to Digital Music
Albums
31

Chapter 21 - Consumer Choice

32

Total and Total utility is

maximized...

Marginal Utility
of Downloading
and Listening
to Digital
…where marginal
utility equals zero.

Music Albums

Chapter 21 - Consumer Choice

 Graphical Analysis
33

 Observations
 Marginal utility falls as more is consumed.
 Marginal
utility equals zero when total utility is at its
maximum.

Chapter 21 - Consumer Choice

 Diminishing Marginal Utility
34

 Diminishing Marginal Utility

 The principle that as more of any good or service is
consumed, its extra benefit declines
 Increases in total utility from consumption of a good or
service become smaller and smaller as more is
consumed during a given time period.

Chapter 21 - Consumer Choice