ECON201 – Lecture 3 – 02/03/23

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02/03/23 Indifference curves

 Parallel
 Downward sloping
 As we move down the gradient diminishes (DMU)

A consumers indifference curves cannot cross

 Consider bundles D and F below

  Bundles D and F are on the same indifference curve, therefore Joe (the individual) must be
indifferent between them
 If another indifference curve through bundle F intersects the original curve, this implies
that Joe is also indifferent between points E and F as well as between points F and D

 Here Joe ranks bundle F = E and F = D, therefore should rank that E = D

 However E is on a higher curve than D
 E is preferred

Tradeoffs along an indifference curve

 Bundle A to B
 Apartment size increases by 250 sq ft, no. Of friends falls by 5
 Utility left unchanged
 Bundle B to C
 Apartment size increases by 250 sq ft, no. Of friends falls by 3
 Utility left unchanged
 Reveals how much Joe values one aspect in relation to the other - 250 sq ft
means more coming from 500 ft than from 750 ft, therefore Joe is willing to
drop more friends at first than he would later
 As apartment size gets larger, Joe is less willing to trade off the number of
friends for additional apartment size
The marginal rate of substitution (MRS)

Indifference curves describe tradeoffs:

 How much of one good are you willing to give up for one more unit of another good?
 The slope of the indifference curve captures this tradeoff
 This slope: MRS
 MRSxy

MRS describes the rate at which one is willing to trade off or substitute exactly 1 unit of good X for more
of good Y, and be equally well off

MRS and MU

As you move down an indifference curve, you experience a diminishing marginal rate of substitution

 Sarah is willing to give up one latte (X) to gain two burritos (Y) and vice versa
 In terms of the change in the level of utility:


 Along an indifference curve the change in utility is zero
 
 Rearranged:

 Finally:

As we move from point A to point B above:

 Q of lattes increases resulting in the MU of lattes to decrease

 Q of burritos decreases resulting in the MU of burritos to increase
 Law of diminishing marginal utility


 MRSxy decreases as you move down the indifference curve

The MRS between two goods is equal to the inverse of the goods marginal utilities:

 Steeper curves imply the consumer is willing to give up a lot of Y to get one unit of X
 Could trade 1 unit of X for a lot of good Y
 Flatter curves imply the consumer would require a large increase in good X to give up one unit of
the good Y
 Could trade 1 unit of Y for a lot of good X

The steepness of indifference curves:

The curvature of indifference curves:

Curvature: substitutes and complements

The shape of indifference curves reveals information about the relationship between products:

 Relatively straight indifference curves

 Goods that are more easily substitutable for one another
 Consumers receive similar level of utility for each good
 MRS is more consistent
 Indifference curves that more convex to the origin
 Goods that are more complementary to one anotheer
 Consumers consume in a more fixed manner
 One product increase is not as similar in increasing utility as another
Perfect substitutes: goods that the consumer will trade at a fixed rate and receive the same level of
utility (MRS is constant)

 Here consumers preferences for 3 ounce and 12 ounce bags of tortilla chips
 Should be willing to trade one 12 ounce bag for four 3 ounce bags no matter how much
of each they have
 MRS constant in this case

Perfect complements: goods that the consumer must consume in a fixed proportion

 E.g here: preferences for right and left shoes

 Most consumers will prefer to consume these in a constant proportion
 Point A: this consumer has two right shoes and two left shoes
 Adding another right shoe (point B) will not increase utility
 Needs another left shoe (point D) if utility is to increase
o Products that have to move evenly with each other in order to
raise utility
The same consumer can have indifference curves with different shapes:

 Initially for low levels of utility (Ua), bananas and strawberries might be substitutes
 As utility increases (Ub), the consumer might prefer a variety of fruit in their diet more
than intitially.