Indifference Curve Analysis 21 C H A P T E R APPENDIX Indifference Curve Analysis

THE BUDGET LINE: What is Attainable 8 0 $12 6 3 12 4 6 12 2 9 12 Units of A Price $1.50 B Price $1.00 Total Expenditures Quantity of A Quantity of B 12 10 8 6 4 2 2 4 6 8 10 12 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12

THE BUDGET LINE: What is Attainable 8 0 $12 6 3 12 4 6 12 2 9 12 Units of A Price $1.50 B Price $1.00 Total Expenditures 12 10 8 6 4 2 2 4 6 8 10 12 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 Quantity of A Quantity of B

THE BUDGET LINE: What is Attainable 8 0 $12 6 3 12 4 6 12 2 9 12 Units of A Price $1.50 B Price $1.00 Total Expenditures 12 10 8 6 4 2 2 4 6 8 10 12 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 Quantity of A Quantity of B

THE BUDGET LINE: What is Attainable 8 0 $12 6 3 12 4 6 12 2 9 12 Units of A Price $1.50 B Price $1.00 Total Expenditures 12 10 8 6 4 2 2 4 6 8 10 12 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 Quantity of A Quantity of B

THE BUDGET LINE: What is Attainable 8 0 $12 6 3 12 4 6 12 2 9 12 Units of A Price $1.50 B Price $1.00 Total Expenditures 12 10 8 6 4 2 2 4 6 8 10 12 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 Quantity of A Quantity of B

THE BUDGET LINE: What is Attainable 8 0 $12 6 3 12 4 6 12 2 9 12 Units of A Price $1.50 B Price $1.00 Total Expenditures 12 10 8 6 4 2 2 4 6 8 10 12 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 (Unattainable) Quantity of A (Attainable) Quantity of B

THE BUDGET LINE: What is Attainable An Increase in income makes the purchase of more of either or both items possible Units of A Price $1.50 B Price $1.00 Total Expenditures 12 10 8 6 4 2 2 4 6 8 10 12 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 (Unattainable) Quantity of A (Attainable) Quantity of B

a change in the quantity THE BUDGET LINE: What is Attainable Price changes cause a change in the quantity demanded of the items Units of A Price $1.50 B Price $1.00 Total Expenditures 12 10 8 6 4 2 2 4 6 8 10 12 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 (Unattainable) Quantity of A (Attainable) Quantity of B

INDIFFERENCE CURVES What is Preferred j 8 0 $12 6 3 12 4 6 12 2 9 12 Units of A Price $1.50 B Price $1.00 Total Expenditures j 12 10 8 6 4 2 2 4 6 8 10 12 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 Quantity of A An Indifference Schedule Combi- nation Units of A of B j 12 2 Quantity of B

INDIFFERENCE CURVES What is Preferred j 8 0 $12 6 3 12 4 6 12 2 9 12 Units of A Price $1.50 B Price $1.00 Total Expenditures j 12 10 8 6 4 2 2 4 6 8 10 12 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 k Quantity of A An Indifference Schedule Combi- nation Units of A Units of B j 12 2 k 6 4 Quantity of B

INDIFFERENCE CURVES What is Preferred j 8 0 $12 6 3 12 4 6 12 2 9 12 Units of A Price $1.50 B Price $1.00 Total Expenditures j 12 10 8 6 4 2 2 4 6 8 10 12 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 k Quantity of A l An Indifference Schedule Combi- nation Units of A Units of B j 12 2 k 6 4 l 4 6 Quantity of B

INDIFFERENCE CURVES What is Preferred j 8 0 $12 6 3 12 4 6 12 2 9 12 Units of A Price $1.50 B Price $1.00 Total Expenditures j 12 10 8 6 4 2 2 4 6 8 10 12 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 k Quantity of A l An Indifference Schedule m Combi- nation Units of A Units of B j 12 2 k 6 4 l 4 6 m 3 8 Quantity of B

INDIFFERENCE CURVES What is Preferred j 8 0 $12 6 3 12 4 6 12 2 9 12 Units of A Price $1.50 B Price $1.00 Total Expenditures j 12 10 8 6 4 2 2 4 6 8 10 12 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 k Quantity of A l An Indifference Schedule m Combi- nation Units of A Units of B I j 12 2 k 6 4 l 4 6 m 3 8 Quantity of B

INDIFFERENCE CURVES What is Preferred j 8 0 $12 6 3 12 4 6 12 2 9 12 Units of A Price $1.50 B Price $1.00 Total Expenditures j 12 10 8 6 4 2 2 4 6 8 10 12 The slope represents the marginal rate of substi- tution, (MRS) 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 k Quantity of A l An Indifference Schedule m Combi- nation Units of A Units of B I2 I1 j 12 2 k 6 4 l 4 6 m 3 8 Quantity of B

INDIFFERENCE CURVES What is Preferred If the consumer Units of A Price $1.50 B Price $1.00 Total Expenditures 12 10 8 6 4 2 2 4 6 8 10 12 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 If the consumer had greater income, more of either or both products could be purchased Quantity of A An Indifference Schedule Combi- nation Units of A Units of B I1 j 12 2 k 6 4 l 4 6 m 3 8 Quantity of B

INDIFFERENCE CURVES What is Preferred A higher combination Units of A Price $1.50 B Price $1.00 Total Expenditures 12 10 8 6 4 2 2 4 6 8 10 12 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 A higher combination of choices will be preferred Quantity of A An Indifference Schedule I4 I3 Combi- nation Units of A Units of B I2 I1 j 12 2 k 6 4 l 4 6 m 3 8 Quantity of B

INDIFFERENCE CURVES What is Preferred An Indifference Map Units of A Price $1.50 B Price $1.00 Total Expenditures 12 10 8 6 4 2 2 4 6 8 10 12 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 An Indifference Map A family of all such expressions of indifference can be developed for every level of income Quantity of A An Indifference Schedule I4 I3 Combi- nation Units of A Units of B I2 I1 j 12 2 k 6 4 l 4 6 m 3 8 Quantity of B

EQUILIBRIUM AT TANGENCY Units of A Price $1.50 B Price $1.00 Total Expenditures 12 10 8 6 4 2 2 4 6 8 10 12 8 0 $12 6 3 12 4 6 12 2 9 12 0 12 12 (Unattainable) Quantity of A An Indifference Schedule I4 I3 Combi- nation Units of A Units of B (Attainable) I2 I1 j 12 2 k 6 4 l 4 6 m 3 8 Quantity of B

EQUILIBRIUM AT TANGENCY occurs when the consumer selects the combination which reaches the highest attainable indifference curve. 12 10 8 6 4 2 2 4 6 8 10 12 (Unattainable) Quantity of A I4 I3 (Attainable) I2 I1 Quantity of B

EQUILIBRIUM AT TANGENCY What happens if the price of B increases to $1.50? The budget line rotates reflecting the reduction in the quantity of B units which is attainable. 12 10 8 6 4 2 2 4 6 8 10 12 PriceB QuantityB $1.00 6 Quantity of A I3 Quantity of B

EQUILIBRIUM AT TANGENCY What happens if the price of B increases to $1.50? The budget line rotates reflecting the reduction in the quantity of B units which is attainable. 12 10 8 6 4 2 2 4 6 8 10 12 PriceB QuantityB $1.00 1.50 6 3 Quantity of A I3 By recording the various quantities demanded at the various prices yields the Demand schedule I2 Quantity of B

DERIVING THE DEMAND CURVE What happens if the price of B increases to $1.50? Plotting the Points yields the Demand Curve for Product B Price of B $1.50 1.00 PriceB QuantityB $1.00 1.50 6 3 By recording the various quantities demanded at the various prices yields the demand schedule. DB 2 4 6 8 10 12 Quantity of B

Key Terms budget line indifference curve marginal rate of substitution (MRS) indifference map equilibrium position Copyright McGraw-Hill/Irwin, Inc. 2005 BACK END

Next… The Costs of Production Chapter 22