The Trinidad and Tobago Economics Association. The Department of Economics, UWI, St. Augustine. April 28 th, Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine.

Presentation hopes to: 1. Introduce and Explain concept of Marginal Utility. 2. Identify the basic tenants of Indifference Curve analysis. 3. Link the theory of Indifference Curves and the Budget Line as it relates to the consumer. 4. Identify the Income and Substitution effects. Overall the concepts should become clearer to the student in relation to this module as identified in the syllabus. 2 Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine.

The IC shows different combinations of goods that yields the same level of utility (satisfaction). 3 Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine.

0 A CADB D C B Football “Tops” Cricket Jerseys IC 4 Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine.

Convex to the origin (similar to demand curve). The indifference curve is drawn on the principle known as the marginal rate of substitution. 5 Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine.

Any combination along the indifference curve will give the consumer the same utility. They would derive the same satisfaction from any combination of good x and good y. The consumer will be indifferent to any point. As the consumer gets less of y they would want more of x. as such, the increased quantity of x is to compensate for the number of y’s which were given up. The converse holds true. (Marginal rate of substitution). 6 Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine.

Either a leftward or rightward shift. Shift of the IC to the right means that the consumer is getting more utility. The converse to that is also true. 7 Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine.

Indicates three (3) things: We can use all of our income to buy good y. We can use all of our income to buy good x. We can use all of our income to buy some combination of good y and good x. 8 Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine.

The relevant patterns of spending between the two goods are illustrated by the slope of the budget line. Changes in income have no impact on the slope of the budget line. When the price of good x increases the budget line gets steeper or moves inwards (closer to origin). The extent of the movement inwards depends on the increase in the price of good x. as price of x decreases the budget line gets flatter. 9 Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine.

Cricket Jerseys Football “Tops” Is this possible? 10 Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine.

An increase in income will cause the budget line to shift to the right. A simultaneous change in the price of both commodities will also cause a shift in the budget line. If both prices increase the budget line shifts to the left (need not be proportionate) and an opposite shift should all prices decrease. 11 Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine.

The combination of goods x and y that yields the highest level of utility given the consumer’s income. It is represented by the point where the IC is tangential to the budget line. 12 Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine.

Cricket Jerseys Football “Tops” IC 13 Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine.

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As a person’s total income rises, assuming prices do not change, we anticipate the quantity purchased of each good to also increase. 15 Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine.

Cricket Jerseys Football “Tops” Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine.

A normal good is a good that is bought in greater quantities as income increases. In the previous example both goods x and y were normal goods. An inferior is one which is purchased in smaller quantities as income increases. Examples includes second hand books. 17 Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine.

Giffen good is one where as prices rise for a particular good, the consumer purchases more of it due to its impact on the disposable income (example potatoes). 18 Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine.

The reduction of the price of the good essentially increases the consumer’s purchasing power, thus leading to an increase in the quantity demanded of the commodity. 19 Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine.

Assuming a rational consumer and normal good, as the price of the good falls the consumer substitutes other goods (whose prices have not changed) with the commodity that had the price decrease. There is an inverse relationship between price and quantity demanded, based on the above assumptions. Thus, as price falls the quantity demanded increases. 20 Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine.

The practical aspects of Indifference Curves and Budget Lines will now be explored. Trinidad and Tobago Economics Association and Department of Economics, UWI, St. Augustine. 21