Indifference Analysis

Indifference analysis

Indifference curves

Constructing an indifference curve
Pears Oranges 30 24 20 14 10 8 6 6 7 8 10 13 15 20 Point a b c d e f g

Combinations of pears and oranges that Clive likes the same amount as 10 pears and 13 oranges

30 28 26 24 22 20 18 16 14 12 10 8 6 4 2 0 0

Constructing an indifference curve
Pears Oranges 30 24 20 14 10 8 6 6 7 8 10 13 15 20 Point a b c d e f g

Pears

2

4

6

8

10

12

14

16

18

20

22

Oranges

30 28 26 24 22 20 18 16 14 12 10 8 6 4 2 0 0

Constructing an indifference curve
a
Pears Oranges 30 24 20 14 10 8 6 6 7 8 10 13 15 20 Point a b c d e f g

Pears

2

4

6

8

10

12

14

16

18

20

22

Oranges

30 28 26 24 22 20 18 16 14 12 10 8 6 4 2 0 0

Constructing an indifference curve
a
Pears Oranges Point a b c d e f g

b

Pears

30 24 20 14 10 8 6

6 7 8 10 13 15 20

2

4

6

8

10

12

14

16

18

20

22

Oranges

30 28 26 24 22 20 18 16 14 12 10 8 6 4 2 0 0

Constructing an indifference curve
a
Pears Oranges Point a b c d e f g

b c

Pears

d

30 24 20 14 10 8 6

6 7 8 10 13 15 20

e

f g

2

4

6

8

10

12

14

16

18

20

22

Oranges

Deriving the marginal rate of substitution (MRS)
30

a ∆Y = 4 MRS = 4 b

26

∆X = 1 Units of good Y
20

MRS = ∆Y/∆X

10

0 0
67

10

20

Units of good X

Deriving the marginal rate of substitution (MRS)
30

a ∆Y = 4 MRS = 4 b

26

∆X = 1 Units of good Y
20

MRS = ∆Y/∆X

10 9

∆Y = 1 ∆X = 1

c

MRS = 1 d

0 0
67

10

13 14

20

Units of good X

30

An indifference map

Units of good Y

20

10

I5 I2
20

I3

I4

0 0 10

I1 Units of good X

The impossibility of two indifference curves crossing
30

Units of good Y

20

a
10

b
0 0 10 20

I1

Units of good X

The impossibility of two indifference curves crossing
30

Units of good Y

20

a
10

b
0 0 10 20

I2 I1

Units of good X

The impossibility of two indifference curves crossing
30

Units of good Y

20

a
10

c b
0 0 10 20

I2 I1

Units of good X

Indifference analysis

Budget lines

A budget line
Units of good X 0 5 10 15 Units of good Y 30 20 10 0

Assumptions PX = £2 PY = £1 Budget = £30

30

a

A budget line
Units of good X Units of Point on good Y budget line 30 20 10 0 a

Units of good Y

20

0 5 10 15

10

Assumptions PX = £2 PY = £1 Budget = £30

0 0 5 10 15 20

Units of good X

30

a

A budget line
Units of good X Units of Point on good Y budget line 30 20 10 0 a b

Units of good Y

20

b

0 5 10 15

10

Assumptions PX = £2 PY = £1 Budget = £30

0 0 5 10 15 20

Units of good X

30

a

A budget line
Units of good X Units of Point on good Y budget line 30 20 10 0 a b c

Units of good Y

20

b

0 5 10 15

10

c

Assumptions PX = £2 PY = £1 Budget = £30

0 0 5 10 15 20

Units of good X

30

a

A budget line
Units of good X Units of Point on good Y budget line 30 20 10 0 a b c d

Units of good Y

20

b

0 5 10 15

10

c

Assumptions PX = £2 PY = £1 Budget = £30

0 0 5 10

d
15 20

Units of good X

Effect of an increase in income on the budget line
40

30

Units of good Y

20
Assumptions

10

PX = £2 PY = £1 Budget = £30

0 0 5 10 15 20

Units of good X

Effect of an increase in income on the budget line
40
Assumptions

30

Units of good Y

PX = £2 PY = £1 Budget = £40

20
16

n m Budget = £40 Budget = £30
0 5
7

10

0 10

15

20

Units of good X

Effect on the budget line of a fall in the price of good X
30
Assumptions PX = £2 PY = £1 Budget = £30

Units of good Y

20

10

0 0 5 10 15 20 25 30

Units of good X

Effect on the budget line of a fall in the price of good X
30
Assumptions PX = £2 PY = £1 Budget = £30

Units of good Y

20

10

0 0 5 10 15 20 25 30

Units of good X

Effect on the budget line of a fall in the price of good X
30
Assumptions PX = £1 PY = £1 Budget = £30

Units of good Y

20

10

0 0 5 10 15 20 25 30

Units of good X

Effect on the budget line of a fall in the price of good X
30

a
Assumptions PX = £1 PY = £1 Budget = £30

Units of good Y

20

10

B1
0 0 5 10

B2 b c
20 25 30

15

Units of good X

Indifference analysis

The optimal level of consumption

Finding the optimum consumption

Units of good Y O Units of good X

Finding the optimum consumption

Units of good Y

I5 I2 I3 I4

O Units of good X

I1

Finding the optimum consumption

Units of good Y

Budget line

I5 I2 I3 I4

O Units of good X

I1

Finding the optimum consumption
r s Units of good Y

Y1

t

u v O I1 X1 Units of good X I2 I3

I5 I4

Indifference analysis

Effects of a change in income

Effect on consumption of a change in income

Units of good Y

a

B1 O Units of good X

I1

Effect on consumption of a change in income

Units of good Y

B1 O

B2

I1

I2

Units of good X

Effect on consumption of a change in income

Units of good Y

B1 O

B2

B3

B4

I1

I2

I3

I4

Units of good X

Effect on consumption of a change in income

Units of good Y

Income-consumption curve

B1 O

B2

B3

B4

I1

I2

I3

I4

Units of good X

Deriving an Engel curve from an income-consumption curve

Bread

B1

B2

I1

I2 B3

I3

CDs

Deriving an Engel curve from an income-consumption curve

Bread

Income-consumption curve I3

B1

B2

I1

I2 B3

CDs

Deriving an Engel curve from an income-consumption curve

Bread

Income-consumption curve I3

B1

B2

I1

I2 B3

CDs Income (£)

Deriving an Engel curve from an income-consumption curve

Bread

Income-consumption curve Qb1

a
B1 Qcd1 B2 I1 I2 B3

I3

CDs

Income (£)

Deriving an Engel curve from an income-consumption curve

Bread

Income-consumption curve Qb1

a
B1 Qcd1 B2 I1 I2 B3

I3

CDs

Income (£)

Y1

a

Qcd1

Deriving an Engel curve from an income-consumption curve

Bread

Qb2 Qb1

a

b

Income-consumption curve I3

B1 Qcd1 Qcd2

B2

I1

I2 B3

CDs

Income (£)

Y2 Y1

b a

Qcd1 Qcd2

Deriving an Engel curve from an income-consumption curve

Bread

Qb3 Qb2 Qb1

a

b

Income-consumption c curve I3

B1 Qcd1 Qcd2 Qcd3

B2

I1

I2 B3

CDs

Income (£)

Y3 Y2 Y1

b a

c

Qcd1 Qcd2 Qcd3

Deriving an Engel curve from an income-consumption curve

Bread

Qb3 Qb2 Qb1

a

b

Income-consumption c curve I3

B1 Qcd1 Qcd2 Qcd3

B2

I1

I2 B3

CDs
Engel curve

Income (£)

Y3 Y2 Y1

b a

c

Qcd1 Qcd2 Qcd3

Effect of a rise in income on the demand for an inferior good

Units of good Y (normal good)

a B1 O Units of good X (inferior good) I1

Effect of a rise in income on the demand for an inferior good

Units of good Y (normal good)

b

I2

a B1 O Units of good X (inferior good) I1 B2

Effect of a rise in income on the demand for an inferior good

Income-consumption curve Units of good Y (normal good) b

I2

a B1 O Units of good X (inferior good) I1 B2

Indifference analysis

Effects of a change in price

Effect of a fall in the price of good X
30
Assumptions PX = £2 PY = £1 Budget = £30

Units of good Y

20

10

0 0 5 10 15 20 25 30

Units of good X

Effect of a fall in the price of good X
30
Assumptions PX = £2 PY = £1 Budget = £30

Units of good Y

20

j
10

0 0 5 10

B1
15 20 25

I1
30

Units of good X

Effect of a fall in the price of good X
30
Assumptions PX = £1 PY = £1 Budget = £30

Units of good Y

20

j
10

0 0 5 10

B1
15 20 25

I1
30

Units of good X

Effect of a fall in the price of good X
30

a
Assumptions PX = £1 PY = £1 Budget = £30

Units of good Y

20

k j
10

I2

0 0 5 10

B1
15 20 25

I1

B2
30

Units of good X

Effect of a fall in the price of good X
30

a

Units of good Y

20

Price-consumption curve

k j
10

I2

0 0 5 10

B1
15 20 25

I1

B2
30

Units of good X

Deriving a demand curve from a price-consumption curve

Expenditure on all other goods

a

B1

I1

Units of good X

Deriving a demand curve from a price-consumption curve
Fall in the price of X a b

Expenditure on all other goods

B1

B2

I1

I2

Units of good X

Deriving a demand curve from a price-consumption curve
Further falls in the price of X a b

Expenditure on all other goods

B1

B2

I1

I2

Units of good X

Deriving a demand curve from a price-consumption curve
Further falls in the price of X a b c d
I4

Expenditure on all other goods

B1

B2

B3

I I1 2 B4

I3

Units of good X

Deriving a demand curve from a price-consumption curve

Expenditure on all other goods

a

b

c

d

Price-consumption curve
I3 I4

B1

B2

B3

I I1 2 B4

Units of good X

Deriving a demand curve from a price-consumption curve

Expenditure on all other goods

a

b

c

d

Price-consumption curve
I3 I4

B1

B2

B3

I I1 2 B4

Units of good X Price of good X P1 a

Q1

Units of good X

Deriving a demand curve from a price-consumption curve

Expenditure on all other goods

a

b

c

d

Price-consumption curve
I3 I4

B1

B2

B3

I I1 2 B4

Units of good X Price of good X P1 a

P2 P3 P4

b c d

Demand Units of good X

Q1 Q2 Q3 Q4

Indifference analysis

Income and substitution effects of a change in price: (a) normal good

Income and substitution effects: normal good

Units of good Y

f

I1 I2 I3 I4 I5 I6

B1 QX1

Units of Good X

Income and substitution effects: normal good

Rise in the price of good X Units of good Y

h f

I1 I2 I3 I4 I5 I6

B2 QX3 QX1

B1

Units of Good X

Income and substitution effects: normal good

Substitution effect of the price rise Units of good Y

g h f

I1 I2 I3 I4 I5 I6

B2 QX3 QX2
Substitution effect

B1a

B1

QX1

Units of Good X

Income and substitution effects: normal good

Income effect of the price rise Units of good Y

g h f

I1 I2 I3 I4 I5 I6

B2 QX3
Incom e

B1a

B1

QX2

Substitution effect

QX1

Units of Good X

Indifference analysis

Income and substitution effects of a change in price: (b) inferior good

Income and substitution effects: Inferior (non-Giffen) good

Units of good Y

f

I1 I2
QX1 Units of Good X B1

Income and substitution effects: Inferior (non-Giffen) good

Rise in the price of good X Units of good Y

f h

I1 I2
B1 Units of Good X

B2 QX3 QX1

Income and substitution effects: Inferior (non-Giffen) good

Units of good Y

g

Substitution effect of the price rise

f h

I1 I2
B1 Units of Good X

B2 QX2 QX1

B1a

Substitution effect

Income and substitution effects: Inferior (non-Giffen) good

Units of good Y

g

Income effect of the price rise

f h

I1 I2
B1 Units of Good X

B2 QX2 QX3
Income effect

B1a

QX1

Substitution effect

Indifference analysis

Income and substitution effects of a change in price: (c) Giffen good

Income and substitution effects: Giffen good

Units of good Y

f

I1

I2
QX1

B1 Units of Good X

Income and substitution effects: Giffen good

Rise in the price of good X Units of good Y

f

I1
h

B2 QX1QX3

I2

B1 Units of Good X

Income and substitution effects: Giffen good

Units of good Y

g f

Substitution effect of the price rise

I1
h

B2 QX2 QX1QX3
Substitution effect

B1a

I2

B1 Units of Good X

Income and substitution effects: Giffen good

Units of good Y

g f

Income effect of the price rise

I1
h

B2 QX2 QX1QX3
Income effect Substitution effect

B1a

I2

B1 Units of Good X

Indifference analysis

Characteristics theory

Choice between brands: characteristics approach
Brand 1 Quantity of characteristic A Brand 2 Quantities of any one of three brands that can be purchased for a given budget at current prices: Brand 1 is chosen Brand 3 x2

QA1

x1

x3 I2 I3

I5 I4

I1 QB1 Quantity of characteristic B

Choice between brands: characteristics approach
Brand 1 Quantity of characteristic A Brand 2 Effect of reductions in the price of Brand 2: Brand 2 is now chosen Brand 3 QA5 x2 x4 x5

x1

x3 I2 I3

I5 I4

I1 QB5 Quantity of characteristic B

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