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Indifference Curve AnalysisIndifference Curve Analysis

Chapter 8 Appendix

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Sophies ChoiceSophies Choice Sophie eats chocolate bars and drinks

soda.

She wants to maximize her utility given abudget constraint.

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Graphing the BudgetGraphing the Budget

ConstraintConstraint Chocolate bars cost $1 and sodas cost 50

cents each.

Sophie has $10 to spend.

She can buy 10 chocolate bars or 20sodas or some combination of each.

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Graphing the BudgetGraphing the Budget

ConstraintConstraint

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Graphing the BudgetGraphing the Budget

ConstraintConstraint The slope of the budget constraint is the

ratio of the prices of the two goods.

The slope changes when the priceschange.

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Graphing the IndifferenceGraphing the Indifference

CurveCurve Indifference curve a curve that shows

combinations of goods among which an

individual is indifferent.

The slope of the indifference curve is theratio of marginal utilities of the two goods.

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Graphing the IndifferenceGraphing the Indifference

CurveCurve The absolute value of the slope of an

indifference curve is called the marginal

rate of substitution.

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Graphing the IndifferenceGraphing the Indifference

CurveCurve Marginal rate of substitution the rate at

which one good must be added when the

other is taken away in order to keep theindividual indifferent between the twocombinations.

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Graphing the IndifferenceGraphing the Indifference

CurveCurve Indifference curves are downward sloping

and bowed inward.

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Graphing the IndifferenceGraphing the Indifference

CurveCurve Lawof diminishing marginal rate of

substitution as you get more and more

of a good, if some of that good is takenaway, then the marginal addition of anothergood you need to keep you on your

indifference curve gets less and less.

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Graphing the IndifferenceGraphing the Indifference

CurveCurve

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A Groupof IndifferenceA Groupof Indifference

CurvesCurves Sophie will have a whole group of

indifference curves, each representing a

different level of happiness.

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A Groupof IndifferenceA Groupof Indifference

CurvesCurves If she prefers more to less, she is better off

with the indifference curve that is farthest

to the right.

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A Groupof IndifferenceA Groupof Indifference

CurvesCurves

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Why Indifference CurvesWhy Indifference Curves

Cannot CrossCannot Cross If indifference curves crossed, it would

violate the prefer-more-to-less principle.

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Why Indifference CurvesWhy Indifference Curves

Cannot CrossCannot Cross

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Indifference Curves andIndifference Curves and

Budget ConstraintsBudget Constraints Sophie will maximize her utility by

consuming on the highest indifference

curve as possible, given her budgetconstraint.

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Indifference Curves andIndifference Curves and

Budget ConstraintsBudget Constraints The best combination is the point where

the indifference curve and the budget line

are tangent.

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Indifference Curves andIndifference Curves and

Budget ConstraintsBudget Constraints The best combination is the point where

the slope of the budget line equals the

slope of the indifference curve.

S

S

C

C

C

S

C

S

P

MU

P

MUthatso

MU

MU

P

P!!

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Indifference Curves andIndifference Curves and

Budget ConstraintsBudget Constraints

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Deriving a Demand CurveDeriving a Demand Curve

from the Indifference Curvefrom the Indifference Curve Demand is the quantity of a good that a

person will buy at various prices.

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Deriving a Demand CurveDeriving a Demand Curve

from the Indifference Curvefrom the Indifference Curve The point of tangency of the indifference

curve and the budget line gives the

quantity that a person would buy at a givenprice.

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Deriving a Demand CurveDeriving a Demand Curve

from the Indifference Curvefrom the Indifference Curve By varying the price of one of the goods

while holding the price of other constant,

the points of tangency will change.

This gives alternative price/quantitycombinations.

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Deriving a Demand CurveDeriving a Demand Curve

from the Indifference Curvefrom the Indifference Curve

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Indifference Curve AnalysisIndifference Curve Analysis

End of Chapter 8 Appendix