In search for higher utility, the consumer faces a constraint — a limited budget or income. The consumer does not have sufficient funds to purchase all combinations of the two goods. The limits imposed by the budget are shown through the consumer’s budget line.
Utility Maximization and Demand
As income rises, you can afford to consume on higher indifference curves. Indifference curve analysis can be used to show why the demand curve usually slopes down. To do this, we will analyse one commodity, beer, and assume that consumer income and the price of all other goods remains constant.
People cannot really put a numerical value on their level of satisfaction. However, they can, and do, identify what choices would give them more, or less, or the same amount of satisfaction. An indifference curve shows all combinations of goods that provide an equal level of utility or satisfaction.
- Clearly, bundles that contain fewer of both goods, like latexBundle D/latex, are worse than latexA/latex, latexB/latex, or latexC/latex because they violate the more-is-better assumption.
- Common utility functions used in economics include the Cobb-Douglas utility function, the Constant Elasticity of Substitution (CES) utility function, and the Perfect Substitutes utility function.
- That is, one unit of one good is just as good as one unit of another good.
Point A on the I2 curve indicates a higher level of satisfaction than point В on the 12 curve, as it lies farther away from the origin. But point С which lies on both the curves yields the same level of satisfaction as point A and B. In between two indifference curves there can be a number of other indifference carves, one for every point in the space on the diagram. The issue of consumer preferences is central to the real-world policy question posed at the beginning of this chapter. what are the properties of indifference curve In the graph below, point A illustrates the tangency condition the utility curve has with the budget line constraint.
CES utility
Each indifference curve is typically convex to the origin and no two indifference curves ever intersect. Consumers are always assumed to be more satisfied when they’re achieving bundles of goods on indifference curves that are farther from the origin. In this diagram at P, the consumer obtains OM of oranges and ON of bananas. Thus it is proved that an Indifference Curve cannot slope upward to the right, nor can it be horizontal or vertical. The only possibility is that it must slope downwards to the right.
Diminishing Marginal Substitutability:
In the above graph, points or combinations A, B, C, D, and E provide the same satisfaction level to Nisha. It can also be seen that as Nisha is consuming one additional quantity of chocolate, she has to sacrifice or give up some quantity of ice cream. Therefore, when Nisha moves from Combination A to B to consume one extra chocolate, she has to sacrifice 8 units of ice-creams. Similarly, to move from Combinations B to C, C to D, and D to E, she has to sacrifice 4, 2, and 1 unit of ice-creams, respectively, for the consumption of one extra unit of chocolate at each movement. This sacrifice of units of a good to gain an additional unit of another good is known as the .
Chapter 2: Consumer’s Equilibrium
She would be willing to give up as many as 2 days of skiing to gain an extra day of horseback riding; the market demands that she give up only one. The marginal decision rule says that if an additional unit of an activity yields greater benefit than its cost, it should be pursued. These arguments about the shapes of indifference curves and about higher or lower levels of utility do not require any numerical estimates of utility, either by the individual or by anyone else. Given these gentle assumptions, a field of indifference curves can be mapped out to describe the preferences of any individual. If indifference curves were not convex, then the consumer would be willing to trade the same amount of one good for a smaller amount of the other good, regardless of the quantity of the goods already consumed. However, this would contradict the assumption of diminishing marginal utility, as the consumer would be gaining the same amount of utility from consuming a smaller amount of the second good.
