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 6

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

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

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

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

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

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

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

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

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 7

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

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

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

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

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

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

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

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

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

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

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 B1 I1 B2 O Units of good X (inferior good)

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

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

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

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 B1 B2 B3 B4 Units of good X

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

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

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

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

INDIFFERENCE ANALYSIS 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) 8

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

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

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

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 QX2 QX1 Income effect Substitution effect Units of Good X Units of Good X

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

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

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 QX2 QX1 Substitution effect Units of Good X Units of Good X

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 QX2 QX3 QX1 Substitution effect Units of Good X Units of Good X Income effect

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

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 I2 B1 QX1 QX3 Units of Good X Units of Good X

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 I2 B1 QX2 QX1 QX3 Substitution effect Units of Good X Units of Good X

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 I2 B1 QX2 QX1 QX3 Substitution effect Units of Good X Units of Good X Income effect

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 9