Term 3

Welcome everyone
Year 12 Economics
By the end of this lesson, students
should be able to:
Understand the indifference
curves and budget lines.
An Indifference Curve:
Definition
• An indifference curve is a curve showing
all the quantity mixes of two goods from
which the consumer derives the same level
of utility.
An indifference curve is a graph showing
combination of two goods that give the
consumer equal satisfaction and utility.
An indifference curve shows bundles of goods that
make the consumer equally happy.
An indifference curve is convex to the origin,
reflecting the principle of diminishing marginal
utility.

The slope of an indifference curve measures the

marginal rate of substitution, MRS.
Each point on an indifference
curve indicates that a
consumer is indifferent
between the two and all
points give him the same
utility.
The above diagram shows the indifference curve
showing bundles of goods A and B. To the consumer,
bundle A and B are the same as both of them give
him the equal satisfaction.

In other words, point A gives as much utility as

point B to the individual. The consumer will be
satisfied at any point along the curve assuming that
other things are constant.
 Consumer’s preferences

The consumer is indifferent, or equally happy, with

the combinations shown at points A, B, and C
because they are all on the same curve.

The Marginal Rate of Substitution: The slope at any

point on an indifference curve is the marginal rate
of substitution.
It is the rate at which a consumer is willing to
substitute one good for another.

It is the amount of one good that a consumer

requires as compensation to give up one unit of the
other good.
The law of diminishing marginal rate of substitution
says that as a persons consumption of pizza
increases, the number of pepsi that they are willing
to give up to get another pizza declines.

This implies that the indifference curve has a

diminishing slope  as we move down the
indifference curve, the consumption of pizza
increases and the marginal utility of additional
pizza declines
 Properties of Indifference Curves

1.Higher indifference curves are preferred to lower

ones.

2.Indifference curves are downward sloping.

3.Indifference curves do not cross.

4.Indifference curves are bowed inward.

Property 1: Higher indifference curves are preferred
to lower ones.

Consumers usually prefer more of something to less

of it. Higher indifference curves represent larger
quantities of goods than do lower indifference
curves. Therefore consumers will prefer to be on
indifference curve, I2 than indifference,I1. That is
on point D.
Property 2: Indifference curves are downward
sloping

A consumer is willing to give up one good only if he

or she gets more of the other good in order to
remain equally happy. If the quantity of one good is
reduced, the quantity of the other good must
increase. For this reason, most indifference curves
slope downward.
Property 3: Indifference curves do not cross.

Points A and B should make the consumer equally

happy.
Points B and C should make the consumer equally
happy.
This implies that A and C would make the consumer
equally happy.
But C has more of both goods compared to A.
Property 4: Indifference curves are bowed inward.

People are more willing to trade away goods that

they have in abundance and less willing to trade
away goods of which they have little.

These differences in a consumer’s marginal

substitution rates cause his or her indifference
curve to bow inward.
BUDGET LINE

Budget line is a graphical representation of all

possible combinations of two goods which can be
purchased with given income and prices , such that
the cost of each of these combinations is equal to
the money income of the consumer. It is also known
as price line.
A line showing all combinations of the quantities of
two goods a consumer can buy with a given amount
of income (budget).
Assuming a consumer is spending all her income on
two (symbolic) consumer goods:
CDs and live concerts

Income = Pc . Qc + PL . QL

Pc = 15 , PL = 120 ,

Income = 1200
Quantity of DC Quantity of live
concert
Properties Of Budget Line

Budget Line Is Downward Sloping:- Budget line has

a negative slope I.e. it slopes downwards as more of
one good can be bought by decreasing some units of
other good
 Budget Line Is Straight Line :- The slope of budget
line is represented by the price ratio. As price ratio
is constant throughout , the budget line is a straight
line.
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THANK YOU