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INDIFFERENCE ANALYSIS

INDIFFERENCE ANALYSIS. Indifference curves constructing an indifference curve the shape of an indifference curve diminishing marginal rate of substitution an indifference map The budget line constructing a budget line effect of a change in income effect of a change in price.

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INDIFFERENCE ANALYSIS

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  1. INDIFFERENCE ANALYSIS • Indifference curves • constructing an indifference curve • the shape of an indifference curve • diminishing marginal rate of substitution • an indifference map • The budget line • constructing a budget line • effect of a change in income • effect of a change in price

  2. Constructing an indifference curve a Pears Point Oranges a b c d e f g 30 24 20 14 10 8 6 6 7 8 10 13 15 20 Pears Oranges

  3. Deriving the marginal rate of substitution (MRS) a b 26 Units of good Y 6 7 Units of good X

  4. Deriving the marginal rate of substitution (MRS) a MRS = 4 DY = 4 b 26 DX = 1 Units of good Y 6 7 Units of good X

  5. Deriving the marginal rate of substitution (MRS) a MRS = 4 DY = 4 b 26 DX = 1 Units of good Y MRS = 1 c d DY = 1 9 DX = 1 6 7 13 14 Units of good X

  6. An indifference map Units of good Y I5 I4 I3 I2 I1 Units of good X

  7. A budget line a Point on budget line a b Units of good X 0 5 10 15 Units of good Y 30 20 10 0 b Units of good Y Assumptions PX = £2 PY = £1 Budget = £30 Units of good X

  8. Effect of an increase in income on the budget line Assumptions PX = £2 PY = £1 Budget = £40 Units of good Y n m 16 Budget = £40 Budget = £30 7 Units of good X

  9. Effect on the budget line of a fall in the price of good X a Assumptions PX = £1 PY = £1 Budget = £30 Units of good Y B2 B1 c b Units of good X

  10. INDIFFERENCE ANALYSIS • The optimum consumption point • equating the marginal rate of substitution with the price ratio • The effect of a change in income • the income–consumption curve • the Engel curve • income elasticity of demand and the income–consumption curve • the effect of a rise in income on the demand for an inferior good

  11. Finding the optimum consumption Units of good Y Budget line I5 I4 I3 I2 I1 O Units of good X

  12. Same slope at t of indifference curve and budget line r s Units of good Y t Y1 u I5 I4 v I3 I2 I1 O X1 Units of good X

  13. Effect on consumption of a change in income Units of good Y B1 I1 O Units of good X

  14. Effect on consumption of a change in income Units of good Y I2 B2 B1 I1 O Units of good X

  15. Effect on consumption of a change in income Units of good Y I4 I3 I2 B2 B3 B1 B4 I1 O Units of good X

  16. Effect on consumption of a change in income Income–consumption curve Units of good Y I4 I3 I2 B2 B3 B1 B4 I1 O Units of good X

  17. Deriving an Engel curve from an income–consumption curve Bread Income-consumption curve Qb3 c Qb2 b a Qb1 I3 I2 I1 B3 B2 B1 Qcd2 Qcd1 Qcd3 CDs Y3 c Income (£) Y2 b Y1 a Qcd1 Qcd2 Qcd3 CDs

  18. Deriving an Engel curve from an income–consumption curve Bread Income-consumption curve Qb3 c Qb2 b a Qb1 I3 I2 I1 B3 B2 B1 Qcd2 Qcd1 Qcd3 CDs Engel curve Y3 c Income (£) Y2 b Y1 a Qcd1 Qcd2 Qcd3 CDs

  19. Effect of a rise in income on the demand for an inferior good Units of good Y (normal good) a I1 B1 O Units of good X (inferior good)

  20. Effect of a rise in income on the demand for an inferior good b Units of good Y (normal good) I2 a I1 B1 B2 O Units of good X (inferior good)

  21. Effect of a rise in income on the demand for an inferior good Income–consumption curve b Units of good Y (normal good) I2 a I1 B1 B2 O Units of good X (inferior good)

  22. Effect of a fall in the price of good X Assumptions PX = £2 PY = £1 Budget = £30 Units of good Y j I1 B1 Units of good X

  23. Effect of a fall in the price of good X a Assumptions PX = £1 PY = £1 Budget = £30 k Units of good Y j I2 I1 B1 B2 Units of good X

  24. Effect of a fall in the price of good X a Price–consumption curve k Units of good Y j I2 I1 B1 B2 Units of good X

  25. Deriving a demand curve from a price–consumption curve Further falls in the price of X a b Expenditure on all other goods c d I4 I3 I2 I1 B4 B3 B1 B2 Units of good X

  26. Deriving a demand curve from a price–consumption curve a Price-consumption curve b Expenditure on all other goods c d I4 I3 I2 I1 B4 B3 B1 B2 Units of good X

  27. Deriving a demand curve from a price–consumption curve a Price-consumption curve b Expenditure on all other goods c d I4 I3 I2 I1 B4 B3 B1 B2 Units of good X a P1 Price of good X b P2 Q1 Q2 Units of good X

  28. Deriving a demand curve from a price–consumption curve a Price-consumption curve b Expenditure on all other goods c d I4 I3 I2 I1 B4 B3 B1 B2 Units of good X a P1 Price of good X b P2 c P3 d P4 Q1 Q3 Q4 Q2 Units of good X

  29. Deriving a demand curve from a price–consumption curve a Price-consumption curve b Expenditure on all other goods c d I4 I3 I2 I1 B4 B3 B1 B2 Units of good X a P1 Price of good X b P2 c P3 d P4 Demand Q1 Q3 Q4 Q2 Units of good X

  30. INDIFFERENCEANALYSIS • The effect of changes in price • the price–consumption curve • deriving the individual's demand curve • Income and substitution effects of a price change • a normal good • an inferior good • a Giffen good (a special type of inferior good)

  31. Income and substitution effects: normal good Units of good Y f I1 I2 I3 I4 I5 B1 I6 QX1 Units of Good X Units of Good X

  32. Income and substitution effects: normal good Rise in the price of good X h Units of good Y f I1 I2 I3 I4 I5 B2 B1 I6 QX3 QX1 Units of Good X Units of Good X

  33. Income and substitution effects: normal good Substitution effect of the price rise g h Units of good Y f I1 I2 I3 I4 I5 B2 B1a B1 I6 QX1 QX2 Substitution effect Units of Good X Units of Good X

  34. Income and substitution effects: normal good Income effect of the price rise g h Units of good Y f I1 I2 I3 I4 I5 B2 B1a B1 I6 QX3 QX1 QX2 Substitution effect Income effect Units of Good X Units of Good X

  35. Income and substitution effects: Inferior (non-Giffen) good Units of Good Y Units of good Y f I1 I2 B1 QX1 Units of Good X Units of Good X

  36. Income and substitution effects: Inferior (non-Giffen) good Units of Good Y Rise in the price of good X Units of good Y f h I1 I2 B2 B1 QX3 QX1 Units of Good X Units of Good X

  37. Income and substitution effects: Inferior (non-Giffen) good Units of Good Y Substitution effect of the price rise g Units of good Y f h I1 I2 B2 B1a B1 QX1 QX2 Substitution effect Units of Good X Units of Good X

  38. Income and substitution effects: Inferior (non-Giffen) good Units of Good Y Income effect of the price rise g Units of good Y f h I1 I2 B2 B1a B1 QX3 QX1 QX2 Substitution effect Units of Good X Units of Good X Income effect

  39. Income and substitution effects: Giffen good Units of Good Y f Units of good Y I1 B1 I2 QX1 Units of Good X Units of Good X

  40. Income and substitution effects: Giffen good Units of Good Y Rise in the price of good X f Units of good Y I1 h B2 B1 I2 QX3 QX1 Units of Good X Units of Good X

  41. Income and substitution effects: Giffen good Units of Good Y Substitution effect of the price rise g f Units of good Y I1 h B1a B2 B1 I2 QX3 QX1 QX2 Substitution effect Units of Good X Units of Good X

  42. Income and substitution effects: Giffen good Units of Good Y Income effect of the price rise g f Units of good Y I1 h B1a B2 B1 I2 QX3 QX1 QX2 Substitution effect Units of Good X Units of Good X Income effect

  43. INDIFFERENCE ANALYSIS • The effect of a change in price on the demand for other goods • The usefulness of indifference analysis • superiority of using ordinal measures • limitations of indifference analysis

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