Slide #1.

Chapter 3 UTILITIES INDIFFERENCE CURVES
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Slide #2.

Budget line 2 Good 2 150 100 50 0 50 100 150 Good 1 Points on the budget line indicate all the bundles of goods that the consumer can afford.
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Slide #3.

Indifference Curve 3 Indifference curve: locus of bundles that provide the consumer with the same level of satisfaction
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Slide #4.

Indifference curves 4 Good 2 (x 2) a b 20 w 140 100 0 10 Good 1 (x 1) Points on the same indifference curve represent bundles yielding the same amount of utility.
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Slide #5.

Indifference Curves 5 Indifference map  Set of indifference curves for a consumer   Every bundle  On an indifference curve Indifference curves  Farther from origin ->Higher utility
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Slide #6.

The Shape of Indifference Curves 6 Indifference curves  Cannot slope upward   Cannot cross each other   Transitivity and nonsatiation assumptions Farther from the origin – higher utility    Nonsatiation assumption Nonsatiation assumption Cannot cross each other Are bowed in toward the origin   Convexity assumption Farther from the origin - higher utility
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Slide #7.

Indifference curves cannot slope upward 7 Good 2 (x 2) E B x a D 0 y C Good 1 (x 1) If an indifference curve ran from a to x, then bundle x would be no better than bundle a despite containing more of both goods. This upward slope of the indifference curve would be a violation of the nonsatiation assumption.
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Slide #8.

Indifference curves cannot cross each other 8 Good 2 (x 2) a b I1 c I2 Good 1 (x 1) 0 If indifference curves I1 and I2 crossed at a, then by transitivity of preferences bundle b would be no better than bundle c despite containing more of both goods. This crossing of indifference curves would be a violation of the nonsatiation assumption
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Slide #9.

Farther from the origin -> higher utility 9 Good 2 (x 2) a 0 w Bundle w must be preferred to bundle a because it contains more of both goods Good 1 (x 1)
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Slide #10.

Bowed-in (b) (a) 10 Good 2 (x 2) Good 2 (x 2) a a c c b b 0 Good 1 (x 1) (a) Bowed-out indifference curves violate convexity of preferences. Bundle c is a weighted average of bundles a and b, but yields lower utility level because it is on an indifference curve that is closer to the origin. 0 Good 1 (x 1) (b) Bowed-in indifference curves satisfy the convexity of preferences. Bundle c, a weighted average of bundles a and b, yields a higher utility level
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Slide #11.

The Marginal Rate of Substitution 11 Marginal rate of substitution (MRS)  Particular point on indifference map  One consumer  Ratio of exchanging goods  Same utility MRS = - ∆x2 / ∆x1
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Slide #12.

The Marginal Rate of Substitution 12 Diminishing marginal rate of substitution  From convexity  Move along the indifference curve   Same utility level MRS decreases
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Slide #13.

Convex preferences and the MRS 13 Good 2 (x 2) 100 a +∆x2 -∆x1 60 b -∆x1 +∆x2 c 10 9 0 10 20 d 100 110 I1 Good 1 (x 1) As the consumer is given bundles containing more and more of good 2, she values an individual unit of good 2 less and less
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Slide #14.

Indifference Curves and Tastes 14 Flat indifference curves  Goods that yield no utility Straight-line indifference curves  Goods that are perfect substitutes   MRS - constant along an indifference curve In a two-good world  Indifference curve - straight line
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Slide #15.

(b) (a) 15Good Good 2 (x 2) 2 (x 2) +∆x2 a 10 9 5 4 0 Good 1 (x ) (a) Flat indifference curves.1The good measured on the horizontal axis is yielding no utility for the consumer. 0 -∆x1 +∆x2 -∆x1 3 8 11 Good 1 (x 1) (b) Straight-line indifference curves: perfect substitutes. The same amount of good 2 is always needed to compensate the consumer for the loss of one unit of good 1.
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Slide #16.

Indifference Curves and Tastes 16 Right-angle indifference curves  Goods that are perfect complements   Must be consumed in a fixed ratio to produce utility In a two-good world  Right angle indifference curves Bowed-out indifference curves  Nonconvex preferences
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Slide #17.

(d) (c) 17 Good 2 (x 2) Good 2 (x 2) 11 10 0 b c a 5 6 I1 +∆x2 +∆x2 -∆x1 b +∆x 2 -∆x1 a -∆x1 0 Good 1 (x Good 1 (x 1) 1) (c) Right-angle indifference curves: (d) Bowed-out indifference curves: perfect complements. Adding any nonconvex preferences and the MRS. As the amount of only one good to bundle a consumer is given bundles containing more yields no additional utility. and more of good 2, he values an individual unit of good 2 more and more.
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Slide #18.

Perfect substitutes 18 Pepsi 0 Coke Mary’s marginal rate of substitution is constant at any bundle of Pepsi and Coke.
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Slide #19.

Optimal Consumption Bundle 19 Optimal consumption bundle  Maximize consumer’s utility   Within the economically feasible set Best bundle  According to consumer’s preferences Characteristics of optimal bundles  Indifference curve tangent to budget line   Slope of indifference curve = MRS = -∆x2/∆x1  Slope of budget line = price ratio = p1/p2 MRS = p1/p2
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Slide #20.

The optimal consumption bundle 20 Good 2 (x 2) B x +1 -3 z -4 e k +1 m n F 0 B’ Good 1 (x 1) At the optimal point e, the indifference curve is tangent to the boundary BB’ of the economically feasible consumption set.
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