Ceasar's Mind

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Indifference Curves

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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 top and right is preferable to a curve shifted left and down, but any point on any particular curve is equally preferable as any other point on that curve. (So, in this picture here, X is just as good as A which is just as good as B.)

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, then the marginal rate of substitution is high and a person would be 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, which means 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: a pen from Walmart is equally preferable to the same pen from anywhere else. On the other hand, perfect complements on the other have L-shaped curves: 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.

Written by Ceasar Bautista

2010/11/14 at 17:28

Posted in Uncategorized

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