Utility Indifference

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    The indifference curve

    The ordinal utility analysis is also knownas indifference curve approach to utility

    maximizationAn indifference curve is the locus of

    infinite combinations of two commodities

    which yield the same total utility to theconsumer

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    Preference Set- IndifferenceCurves

    Indifference Curve:Combination of goods that yield the same

    level of satisfaction. Properties of Indifference curves:

    - Slope downward

    - Convex to the origin- Non intersecting

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    Slope of indifference curve

    The marginal rate of substitution is theslope of indifference curve.

    The amount of rice that a consumer iswilling to give up to obtain one additionalunit of wheat.

    MRS = R/W = -MUw/MUr

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    Opportunity Set

    Defined by Budget Constraint.Pw=$1 +PR=$2 = $50

    Graphically,

    -Px/Py is the Slope

    50

    R

    25

    W

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    Slope of the budget constraint

    The marginal rate of transformation (MRT) The trade off the market imposes on the

    consumer in terms of the amount of onegood the consumer must give up to obtainmore of the other good.

    MRT= - PW/ PR = -1/2

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    What is a Budget Constraint?

    A budget constraint shows the consumerspurchase opportunities as every combination of

    two goods that can be bought at given pricesusing a given amount of income.

    The budget constraint measures thecombinations of purchases that a person can

    afford to make with a given amount of monetaryincome.

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    Consumers Equilibrium- TheOptimal Combination

    e

    x

    y

    At e slope of the budget line is equal to the slope

    of the Indifference curve.

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    Consumers Equilibrium

    Slope of the budget line: - Px/Py

    Slope of Indifference curve: MUx/MUy

    Equilibrium : MUx/MUy = Px/Pyor MUx/Px= MUy/Py

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    Chapter 3

    Comparative Statics andDemand

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    Price consumption Curve

    By changing of price x while constant theprice of y and consumers tastes and moneyincome, we can drive the consumers price

    consumption curve and demand curve forcommodity x. the price consumption curvefor commodity x is the locus of points ofconsumer equilibrium resulting when only theprice of x is varied. The consumer demandcurve for commodity x shows the amount ofx that the consumer would purchase at

    various prices of x, ceteris paribus.

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    Changes in equilibrium whenprices change

    Relative price changes get reflected in changesin

    slope of the budget line.

    New point of tangency between the indifference

    curve and the new budget line

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    Effect of a Change in the Price ofSoup on Consumption

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    Individual Demand Curves

    Price-consumption curve includes all theinformation needed to plot an individualsdemand curve

    An individual demand curve: Describes the relationship between the prices of a

    good and the amount a consumer purchases

    Holds everything else fixed

    Price elasticity of demand measures sensitivity ofamount purchased to changes in the goodsprice

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    Individual Demand Curve for Soup

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    Income and Demand

    Income is another important consideration in consumerdecisions

    A change in consumption that results from a change inincome is called an income effect

    How do a consumers choices vary as his incomechanges?

    The income-consumption curveshows this, holdingeverything else fixed

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    Effect of a Change in Income onConsumption

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    Engel Curves

    The Engel curve for a good shows the relationshipbetween income and the amount consumed, holdingeverything else fixed

    Measure income on the vertical axis and amountconsumed on the horizontal axis

    Engel curve slopes upward for a normal good anddownward for an inferior one

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    Engel Curves for Soup andPotatoes