Microeconomics 1

WEEK 6
Variety of Preferences

03 Kasım 2021 Çarşamba / 03 November 2021 Wednesday

05 Kasım 2021 Cuma / 05 November 2021 Friday

 CHARACTERISTICS of INDIFFERENCE CURVES
1. (Definition, at the same time.) The level of utility along a given IC curve is
constant, or say, unchanged.
2. There are so many possible levels of utility  There are so many IC curves
on the commodity plane. There is only one IC curve for every level of
utility.  IC family / IC map
3. The greater the level of utility the higher the IC curves. The smaller the
level of utility the lower the IC curves.
4. IC curves cannot cross each other. If they did the the «transitivity» and the
«nonsatiation» properties would be violated.
5. IC curves are negatively sloped.
6. IC curves are convex, generating diminishing marginal rate of substitution
among two goods in question.
Indifference Curves Can Not Intersect! Why?
y
Bundle A and C are on indifference curve i 1 .

A B Bundle B and C are on indifference curve i 2 .

Bundle B is better than A : u (B) > u (A)

C Thus Bundle B must be better than C, too. Because Bundle A
i1 and C are on the same indifference curve, meaning that they
are equally well.
i2
However, bundle C is also on indifference curve i 2 .
Therefore, bundle C must be as satisfactory as bundle B.
x
So, the intersection of two indifference curves can not take
place because if they did the properties of transitivity and
nonsatiation would be violated.
 MARGINAL RATE OF SUBSTITUTION
• What is an indifference curve actually?

• What information can we get from a particular indifference curve, other than its being
made up of equally satisfactory bundles?

• We can see in what way the consumer deals with the possible tradeoffs that they face,
while trying to hold on to the same indifference curve.

• Because an IC is at the same time a series of possible tradeoffs among the two goods.

• If the consumer wants to switch from one bundle to another, for example, as a reaction
to changing circumstances, the tradeoff that they face will not be the same on every
portion/point of a given IC.
 MARGINAL RATE OF SUBSTITUTION
Lahmacun ( units per week)
From Bundle A to B :
The consumer is willing to give up 4 units of
12 A lahmacun for having 2 more units of pizza.
-4 From Bundle C to D:
8 B The consumer is willing to give up only one unit
of lahmacun to have 2 more units of pizza.
C
-1
4 D
3 U0

6 8 14 16 Pizza ( units per week)

+2 +2
 MARGINAL RATE OF SUBSTITUTION
Lahmacun ( units per week) From Bundle A to B :
The opportunity cost of having 2 more units of pizza
A in terms of lahmacun is 4  opp cost= - (- 4/2) = 2
12
-4 From Bundle C to D:
8 B The opportunity cost of having 2 more units of pizza
in terms of lahmacun is 1  opp cost= - (- 1/2) = 1/2
C
-1
4 D
3 U0

6 8 14 16 Pizza ( units per week)

+2 +2
DIMINISHING MARGINAL RATE OF SUBSTITUTION
y
d • MRS XY = The rate at which one good is substituted
for another in consumption.

• It is equal to the absolute value of the slope of the IC

k curve at hand.

• It decreases as we go down along the IC curve.

the slope of line d > the slope of line k > the slope of line l
 Why is the MRS XY diminishing?
y The slope btw points A and A′ = (y2 – y1) / (x2 – x1)
d
 [ MRS XY ] A  B = - [ (y2 – y1) / (x2 – x1) ]
A
A′ Let the change in y be : Δ y = y2 – y1
y1
Let the change in x be : Δ x = x2 – x1

y2 Then the slope is : s=Δy/Δx

x
x1 x2
Why is the MRS XY diminishing? Btw points A and A′ : ( Δ y ) AA ′ = y2 – y1
y ( Δ x ) AA ′ = x2 – x1
d
 the slope AA ′ = ( Δ y ) AA ′ / ( Δ x ) AA ′
A  MRS AA ′ = - [( Δ y ) AA ′ / ( Δ x ) AA ′ ]
A′
Btw points B and B′ : ( Δ y ) BB′ = y4 – y3
y1 k ( Δ x ) BB ′ = x3 – x4
y2 B
B′  the slope BB ′ = ( Δ y ) BB ′ / ( Δ x ) BB ′

y3  MRS BB′ = - [( Δ y ) BB ′ / ( Δ x ) BB ′ ]
y4 x1 x2 x3 x4 x
 Derivation of MRS xy
u=u(x,y)  the utility function

 By taking the total differential of both sides, we obtain:

du= (∂u/∂x)dx +(∂u/∂y)dy

 d u = 0 Why ?

Because we are on the same indifference curve and are trying to derive its slope!

0 = (∂u/∂x)dx + (∂u/∂y)dy

 - (∂u/∂y)dy = (∂u/∂x)dx

 - dy/dx = (∂u/∂x) / (∂u/∂y)

 dy/dx = - (∂u/∂x) / (∂u/∂y)

du= (∂u/∂x)dx +(∂u/∂y)dy

The partial derivative of the utility function u with respect to ( wrt, henceforth ) the quantity of first good,
Good X  means what?

∂ u ( x , y ) / ∂ x = ∂ u / ∂ x  Marginal Utility of Good X = MU X

The partial derivative of the utility function u wrt the quantity of second good, Good Y :

∂ u ( x , y ) / ∂ y = ∂ u / ∂ y  Marginal Utility of Good Y = MU Y

MARGINAL UTILITY OF GOOD X :

MU X = ∂ u / ∂ x  How much the utility will change once we change the amount of Good
X by one unit, while we hold the quantity of Good Y constant.

MARGINAL UTILITY OF GOOD Y :

MU Y = ∂ u / ∂ y  How much the utility will change once we change the amount of Good
Y by one unit, while we hold the quantity of Good X constant.
 THE LAW OF DIMINISHING MARGINAL UTILITY
If we have only one good:

u = u ( x )  u′ = u′ ( x ) > 0 but u″ = u″ ( x ) < 0

When we consume one more unit of the good X, our utility increases  marginal utility is
positive.

However, if we consume more additional units of Good X, the amount of increase in our
utility will tend to decrease! This tendency is referred to the law of diminishing marginal
utility.
Suppose that: u = x ½  u′ = ½ x - 1/2 and u″ = - ¼ x - 3/2

x u=x½ u′ = ½ x - 1/2 u″ = - ¼ x - 3/2

1 1 ½ (1) = 1/2 (-1/4) (1)

2 ½ (1/1.41) = 1 / 2.82 (-1/4)(1/2.8)

3 ½ (1/1.73) = 1 / 3.46 (-1/4) (1/5.2)

4 ½ (1/2) = ¼ (-1/4) (1/8)

Suppose that: u = x ½  u′ = ½ x - 1/2 and u″ = - ¼ x - 3/2

x u=x½ u′ = ½ x - 1/2 u″ = Δ MU

1 1 ½ (1) = 1/2 -

2 ½ (1/1.41) = 1 / 2.82 (1/2.8) – (1/2) = - 0.14

3 ½ (1/1.73) = 1 / 3.46 (1/2.8) – (1/3.5) = - 0.07
4 ½ (1/2) = ¼ (1/4) – (1/3.5) = - 0.04
Suppose that: u = f ( x )

x Total Utility Marginal Utility Δ (Marginal Utility)

1 10 10

2 17 7 - 3

3 22 5 - 2

4 26 4 - 1
 THE LAW OF DIMINISHING MRS

If we have two goods:

u = u ( x , y )  ux = ∂ [ u( x,y ) ] / ∂ x > 0 and uy = ∂ [ u ( x,y ) ] / ∂ y > 0

Both of the marginal utilities are positive but also diminishing:

uxx = ( MUX ) ′ = ∂ 2 [ u( x,y ) ] / ∂ x 2 < 0

uyy = ( MUy ) ′ = ∂ 2 [ u( x,y ) ] / ∂ y 2 < 0

 THE LAW OF DIMINISHING MRS
If we want to consume more of Good X we must decrease our consumption of Good Y. ( We go down
along the indifference curve! ) This results in the following:

 x ↑  MUX ↓ and y ↓  MUy ↑

 Then, what happens to MRSXY ?

[ Recall that MRS is negative of the slope and is equal to the ratio of marginal utilities! ]

As x increases and y decreases the ratio MUX / MUY DECREASES. Because the value of the numerator

( MUX ) decreases and the value of the denominator ( MUY ) increases over the course of downward
movement along the IC.

This tendency is referred to as the law of diminishing marginal utility.

Why is the MRS XY diminishing?
y The slope btw points A and A′ = (y2 – y1) / (x2 – x1)
d
 [ MRS XY ] A  A′ = - [ (y2 – y1) / (x2 – x1) ]
A
A′ Let the change in y be : Δ y = y2 – y1
y1
Let the change in x be : Δ x = x2 – x1

y2 Then the slope is : s=Δy/Δx

x
x1 x2
Why is the MRSXY diminishing?
Btw points A and A′ : MRS AA ′ = - [( Δ y ) AA ′ / ( Δ x ) AA ′ ]

y d
Btw points B and B′ : MRS BB′ = - [( Δ y ) BB ′ / ( Δ x ) BB ′ ]

Over AA′  x : relatively small; y : relatively large

Over AA′  MUX : relatively high; MUY : relatively low
A Therefore MRSXY = MUX / MUY : relatively HIGH

A′
Over BB′  X : relatively large; y : relatively small
y1 Over BB′  MUX : relatively low; MUY : relatively high
y2 Therefore MRSXY = MUX / MUY : relatively LOW
B
B′
k
y3
y4 x1 x2 x3 x4 x
How does MRSXY change along a given IC ?
y d
MRSXY : relatively HIGH

A
A′
y1
y2
MRSXY : relatively LOW
B
B′
k
y3
y4 x1 x2 x3 x4 x
TYPES of PREFERENCES
PREFERENCE Product X Product Y Shape of the IC MRS XY
Well-behaved GOOD GOOD CONVEX Positive and Decreasing
( Cobb-Douglas )
Perfect Substitutes GOOD GOOD CONVEX Positive and Constant

Perfect GOOD GOOD L-Shaped Zero-Undefined-Infinite

Complements
Quasi-linear GOOD GOOD CONVEX Positive and Decreasing

Neutral Goods Neutral GOOD Vertical / Horizontal Infınıte / Zero

Good
BADS BAD GOOD Convex / Concave Negative and
Increasing/Decreasing
Repulsive GOOD GOOD CONCAVE Positive and Increasing
combinations
Satiated GOOD GOOD Closed curves Positive/Negative
Increasing / Decreasing
WELL-BEHAVED / COBB-DOUGLAS
PREFERENCES

u = xayb
Examples : u = x 1/2 y 1/3 v = x2 y
PERFECT SUBSTITUTES
PERFECT COMPLEMENTS