Indifference Analysis

1
Indifference Analysis
ECN 112 Lecture February 15, 1999 Igor Lukashin
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Indifference Curves

• Indifferent
• Lacking any preference
• Indifference Curve
• a curve showing all combinations of two goods
  that the consumer is indifferent among
• Graphing Indifference Curve
• Axes Goods X and Y (appropriate units , e.g.
  gallons of gas vs. pounds of apples)

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Constructing an Indifference Curve
Start at some initial endowment, say A (10
bananas and 2 apples) Whats the minimum number
of apples you would be willing to accept in
exchange for 1 banana? -1? 0? .1? 1? 2? Whats
the maximum number of apples youd reject to
exchange?
Apples,
E
D
4
A
C
2
B
10
9
Bananas,
4
Constructing an Indifference Curve
Now, at point D, ask yourself again, Whats the
minimum amount of apples Id accept for 1
banana? You have less bananas than in A, so MU of
a banana is higher, and more apples, so MU of
extra apple is lower Have to accept more apples
per banana than in A something like F
Apples,
F
E
D
4
A
C
2
B
10
9
Bananas,
5
Constructing an Indifference Curve
Repeat the steps above, and you will get a set
of points, or consumption bundles, among which
you are indifferent. Then you can draw a curve
through these points, the indifference curve
Apples,
F
E
D
4
A
C
2
B
10
9
Bananas,
6
Unlikely Shapes of Indifference Curves Vertical
Vertical Indifference Curves violate the
condition that more is preferred to less, as, for
example, D has 2 more apples than C and the same
number of bananas
Apples,
F
E
D
4
A
C
2
B
10
9
Bananas,
7
Unlikely Shapes of Indifference Curves Horizontal
Horizontal Indifference Curves violate the
condition that more is preferred to less, as, for
example, A has 1 more bananas than C and the same
number of apples
Apples,
F
E
D
4
A
C
2
B
10
9
Bananas,
8
Unlikely Shapes of Indifference Curves
Upward-Sloping
Upward-Sloping Indifference Curves violate the
condition that more is preferred to less, as, for
example, A has 1 more bananas and about 1 more
apples than B does
Apples,
F
E
D
4
C
2
A
B
10
9
Bananas,
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Properties of Indifference Curves
Bowed-In Consumers value the good relatively
more if they have less of it, ceteris paribus
(diminishing marginal utility)
Apples,
F
E
D
4
C
2
A
B
10
9
Bananas,
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Properties of Indifference Curves
Indifference Curves do not Cross Suppose they
did. Then consumer is indifferent between D and
A, and between A and E, therefore, indifferent
between D and E. But E clearly provides more
apples than D at the same amount of bananas
I1
I2
Apples,
F
E
D
4
A
C
2
B
10
9
Bananas,
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An Indifference Map
Indifference Map A complete set of indifference
curves Indicates preferences among all
combinations of goods and services. The farther
the indifference curve from origin, the more
preferred are combinations of goods along that
curve
More is preferred to less
Apples,
4
2
10
9
Bananas,
12
Budget Constraint
Budget Line a line showing all the combinations
of goods that can be purchased with a given level
of income Suppose you have 3 P(apple)
0.20 P(banana) 0.30 What combinations of
apples and bananas can you buy?
15
Apples,
4
2
10
9
Bananas,
13
Budget Constraint Shifts
Suppose you now have only 1.80 P(apple)
0.20 P(banana) 0.30 What combinations of
apples and bananas can you buy? Can buy 6 bananas
0 apples, or 9 apples and zero bananas.
Budget Line Shift due to decrease in Income
15
9
Apples,
6
10
Bananas,
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Budget Constraint Shifts
Suppose you now have 3.00, but P(apple)
0.30 P(banana) 0.30 Apples are relatively
more expensive What combinations of apples and
bananas can you buy? Can buy 10 bananas 0
apples, or 10 apples and zero bananas.
Budget Line Shift due to change in Relative Price
15
10
Apples,
6
10
Bananas,
15
Consumer Equilibrium
What is the combination of goods that consumer is
both willing and able to purchase? Willing the
higher indifference curve, the better Able point
on or inside the budget line Equilibrium
indifference curve just touches (tangent to) the
budget line. Maximum satisfaction given the
budget. Why?
.
A
15
Unattainable Combinations
C
6
Apples,
B
6
10
Bananas,
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Deriving Demand From Consumer Equilibrium
.
Change the price of one good, holding everything
else constant, find equilibrium
quantity P(apples .20, Q 6 P(apple) .30,
Q 5 P(apple) .50, Q 3 and so on
15
C
6
Apples,
6
10
Bananas,