Question

Please answer both Questions and Please Do Not forget to show with two dimensional model

d) What are indifference curves ? Develop and demonstrate via a two dimensional model.

e) Given indifference curves, how is a decision made as to choices ?
Demonstrate.

thank you

Answer 1

d) An indifference curve is a graph that shows a combination of two goods that give a consumer equal satisfaction and utility, thereby making the consumer indifferent.

Graphically, the indifference curve is drawn as a downward sloping convex to the origin. The graph shows a combination of two goods that the consumer consumes. The indifference curve is convex because of diminishing marginal utility. The indifference curve is downward sloping because of inverse relationship among goods. To consume one extra unit of Good A one need to give up certain units of Good B.

A(10 units, 20 units) Good A B(30 units , 12 units) Indifference curve U Good B

The diagram shows the U indifference curve showing bundles of goods A and B. To the consumer, bundle A and B are the same as both of them give him the equal satisfaction. In other words, point A gives as much utility as point B to the individual. The consumer will be satisfied at any point along the curve assuming that other things are constant.

e) An Indifference Map is a set of Indifference Curves. It depicts the complete picture of a consumer’s preferences.

All choices on IC2 give the same utility. But, it will be a higher net utility than indifference curve IC1.

IC3 gives the highest net utility. Basically, IC3 would require higher income than I1.

YA Good Y 1C3 1C2 1C1 →X Good X 1

A consumer’s choices are limited by the budget available. Total spending for goods and services can fall short of the budget constraint but may not exceed it.

Marginal Rate of Substitution is the rate at which a consumer is prepared to exchange a good X for Y.

Algebraically, we can write the budget constraint for two goods X and Y as:

P_XQ_X+P_YQ_Y≤B

where P_X and P_Y are the prices of goods X and Y and Q_X and Q_Y are the quantities of goods X and Y chosen. The total income available to spend on the two goods is B, the consumer’s budget. It states that total expenditures on goods X and Y (the left-hand side of the equation) cannot exceed B.

A budget line shows the combination of goods that can be afforded with your current income.

R S N Good Y ICS ICA ICZ -ICZ IC LX O M Good X

The highest indifference curve possible for a given budget line is tangent to the line; the indifference curve and budget line have the same slope at that point. The absolute value of the slope of the indifference curve shows the MRS between two goods. The absolute value of the slope of the budget line gives the price ratio between the two goods; it is the rate at which one good exchanges for another in the market. At the point of utility maximization, then, the rate at which the consumer is willing to exchange one good for another equals the rate at which the goods can be exchanged in the market. For any two goods X and Y, with good X on the horizontal axis and good Y on the vertical axis,

MRS_X.Y=P_X/P_Y

Hence, to maximize utility, a consumer chooses a combination of two goods at which an indifference curve is tangent to the budget line. In this example it is point Q.