Indifference Curve Analysis

Chapter 8 Appendix

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 Sophie’s Choice
 Sophie eats chocolate bars and drinks
soda.
 She wants to maximize her utility given a
budget constraint.

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 Graphing the Budget
Constraint
 Chocolate bars cost $1 and sodas cost 50
cents each.
 Sophie has $10 to spend.
 She can buy 10 chocolate bars or 20
sodas or some combination of each.

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 Graphing the Budget
Constraint

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 Graphing the Budget
Constraint
 The slope of the budget constraint is the
ratio of the prices of the two goods.
 The slope changes when the prices
change.

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 Graphing the Indifference
Curve
 Indifference curve – a curve that shows
combinations of goods among which an
individual is indifferent.
 The slope of the indifference curve is the
ratio of marginal utilities of the two goods.

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 Graphing the Indifference
Curve
 The absolute value of the slope of an
indifference curve is called the marginal
rate of substitution.

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 Graphing the Indifference
Curve
 Marginal rate of substitution – the rate at
which one good must be added when the
other is taken away in order to keep the
individual indifferent between the two
combinations.

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 Graphing the Indifference
Curve
 Indifference curves are downward sloping
and bowed inward.

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 Graphing the Indifference
Curve
 Law of diminishing marginal rate of
substitution – as you get more and more
of a good, if some of that good is taken
away, then the marginal addition of
another good you need to keep you on
your indifference curve gets less and less.

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 Graphing the Indifference
Curve

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 A Group of Indifference
Curves
 Sophie will have a whole group of
indifference curves, each representing a
different level of happiness.

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 A Group of Indifference
Curves
 If she prefers more to less, she is better off
with the indifference curve that is farthest
to the right.

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 A Group of Indifference
Curves

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 Why Indifference Curves
Cannot Cross
 If indifference curves crossed, it would
violate the “prefer-more-to-less” principle.

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 Why Indifference Curves
Cannot Cross

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 Indifference Curves and
Budget Constraints
 Sophie will maximize her utility by
consuming on the highest indifference
curve as possible, given her budget
constraint.

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 Indifference Curves and
Budget Constraints
 The best combination is the point where
the indifference curve and the budget line
are tangent.

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 Indifference Curves and
Budget Constraints
 The best combination is the point where
the slope of the budget line equals the
slope of the indifference curve.

PS MUS MUC MUS

 so that 
PC MUC PC PS

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 Indifference Curves and
Budget Constraints

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 Deriving a Demand Curve
from the Indifference Curve
 Demand is the quantity of a good that a
person will buy at various prices.

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 Deriving a Demand Curve
from the Indifference Curve
 The point of tangency of the indifference
curve and the budget line gives the
quantity that a person would buy at a given
price.

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 Deriving a Demand Curve
from the Indifference Curve
 By varying the price of one of the goods
while holding the price of other constant,
the points of tangency will change.
 This gives alternative price/quantity
combinations.

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 Deriving a Demand Curve
from the Indifference Curve

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 Indifference Curve Analysis

End of Chapter 8 Appendix

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