File Name: budget line and indifference curve .zip
Economists typically use a different set of tools than those presented in the chapter up to this point to analyze consumer choices.
- Understanding Consumer’s Equilibrium by Indifference Curve Analysis | Microeconomics
- How to derive Individual’s Demand Curve from indifference Curve Analysis? (with diagram)
- Indifference curves
- Indifference curves and budget lines
Understanding Consumer’s Equilibrium by Indifference Curve Analysis | Microeconomics
An indifference curve, with respect to two commodities, is a graph showing those combinations of the two commodities that leave the consumer equally well off or equally satisfied—hence indifferent—in having any combination on the curve. Indifference curves are heuristic devices used in contemporary microeconomics to demonstrate consumer preference and the limitations of a budget. Economists have adopted the principles of indifference curves in the study of welfare economics. Standard indifference curve analysis operates on a simple two-dimensional graph. Each axis represents one type of economic good. Along the curve or the line, the consumer has no preference for either combination of goods because both goods provide the same level of utility to the consumer.
An indifference curve is a line showing all the combinations of two goods which give a consumer equal utility. In other words, the consumer would be indifferent to these different combinations. The indifference curve is convex because of diminishing marginal utility. When you have a certain number of bananas — that is all you want to eat in a week. Extra bananas give very little utility, so you would give up a lot of bananas to get something else. All choices on I2 give the same utility. But, it will be a higher net utility than indifference curve I1.
How to derive Individual’s Demand Curve from indifference Curve Analysis? (with diagram)
Consumer equilibrium refers to a situation, in which a consumer derives maximum satisfaction, with no intention to change it and subject to given prices and his given income. The point of maximum satisfaction is achieved by studying indifference map and budget line together. Image Courtesy : wikieducator. On an indifference map, higher indifference curve represents a higher level of satisfaction than any lower indifference curve. So, a consumer always tries to remain at the highest possible indifference curve, subject to his budget constraint. As a result, the consumer buys more of X. As a result, MRS falls till it becomes equal to the ratio of prices and the equilibrium is established.
The starting point for indifference analysis is to identify possible baskets of goods and services which yield the same utility usefulness, or satisfaction to consumers. It is assumed that individuals, faced with a budget constraint, will choose the basket that maximises their total utility — in other words, they will act rationally when allocating their budget. Indifference analysis, therefore, provided a solution to the long-standing problem of how to measure utility. Indifference curve analysis makes four essential assumptions about consumer choices and decision-making. No other options are possible. Indifference curve theory assumes that preferences will be consistent, given the same information and constraints. In other words, if the decision-making context for an individual remains constant on both Monday and Tuesday, then a consumer will have the same order of preference on Tuesday as on Monday.
Indifference curves and budget lines
A demand curve shows how much quantity of a good will be purchased or demanded at various prices, assuming that tastes and preferences of a consumer, his income, prices of all related goods remain constant. This demand curve showing explicit relationship between price and quantity demanded can be derived from price consumption curve of indifference curve analysis. In Marshallian utility analysis, demand curve was derived on the assumptions that utility was cardinally measurable and marginal utility of money remained constant with the change in price of the good. In the indifference curve analysis, demand curve is derived without making these dubious assumptions. Let us suppose that a consumer has got income of Rs. In Fig.
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The U. We are using the tools of microeconomic consumer theory to study this policy and assess the effectiveness of this policy in reducing emissions. We are now very close to being able to predict how consumers will change their driving and gasoline purchases in response to a government tax credit on hybrid cars. As we will see, this is simply a specific example of the general question we first raised in Module 1 of how to predict consumer behavior when prices or incomes change. For our policy example and in general, we address this question by combining the budget constraint with the concept of preferences and utility maximization. All of consumer theory in economics is based on the premise that each person will try to do his or her best given the money they have and the prices of the goods and services they like.
Indifference curve map
If we combine data for the budget lines and indifference curves we can establish when a consumer is in equilibrium and maximising their utility. This is the only point at which the gradient of the budget line and indifference curve are identical. Hence, we have:. When this condition is met the individual is maximising their total utility. The price-consumption line Indifference analysis can help us understand how demand responds to changes in price. Indifference curves can be used to derive a demand curve.
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