Indifference Curves
An indifference curve is a line that shows combinations of goods among which a consumer is indifferent. Since consumers always prefer more over less, a curve shifted to the right is preferable to a curve shifted leftward, but any point on a particular line is preferred the same as any other point on that line. (So, in this picture here, X is just as good as Y.)
The marginal rate of substitution (MRS) is the rate at which a person will give up good y (measured on the y axis) for good x (measured on the x axis) while remaining indifferent. The magnitude of the slope of an indifference curve measures the marginal rate of substitution. That is, if the indifference curve is steep, the marginal rate of substitution is high. The person is willing to give up a very large amount of y to obtain very little of x. If the curve is flat, the marginal rate of substitution is low. The person is willing to give up very little of y to obtain large quantities of x. Generally, there is a diminishing marginal rate of substitution, such that people becomes more and more willing to give up large amounts of x for y when they have very little y.
For ordinary goods, we see curves that look like the one above. But sometimes the value of a good is influenced by another. For example, perfect substitutes will produce straight diagonal lines with slope -1. That is, a Marine from one Barracks in your base is just as good as a Marine from another Barracks in your base. Perfect complements on the other have L-shaped curves. Consider shoes. A left shoe is worth nothing without the right, and two left shoes are worth nothing without two right shoes.
Predicting Consumer Choice
The best affordable choice is 1)on the budget line and 2) on the highest attainable indifference curve. This point is where marginal rate of substitution equals relative price. Changes in the price or utility of a good, or a person’s income change the best affordable point.
