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THEORY OF CONSUMER CHOICE (INDIFFERENCE CURVES. (4 PROPERTY OF…
THEORY OF CONSUMER CHOICE
INDIFFERENCE CURVES.
MARGINAL RATE OF SUBSTITUTION (MRS)
4 PROPERTY OF INDIFFERENCE CURVES
HIGHER
indifference curves are
preferred
to
LOWER
ones
Indifference curves are
DOWNWARD SLOPING
Indifference curves
DO NOT CROSS
Indifference curves are
BOWED INWARD*
Shows consumption
bundles
that give the consumer the
same level of SATISFACTION
KEYWORDS: CONSUMPTION BUNDLES, SAME LEVEL OF SATISFACTION
BUDGET CONSTRAINT.
Depicts the limit on the consumption "
bundles
"
People consume
less
than they desire because their spending is
limited
by their
income
RELATIVE PRICE
Example: 2 pepsi = 1 pizza
Relative Price is
TRADE
On the graph:
straight line, touch axis x and y, point A B C D and E, E is not possible(outside of the curve), D is possible(inside of the curve)
PERFECT COMPLEMENT.
Goods or services that can be
complements
perfectly
Since these goods are always used together, extra units of one good, outside the desired consumption ratio, add no additional satisfaction
Right-angle indifference curve
NORMAL GOODS
VS.
INFERIOR GOODS.
NORMAL GOOD is when
income
RISES
, consumer buys
MORE
goods
NG: Income
RISES
=
MORE
goods
INFERIOR GOOD is when
income
RISES
, consumer buys
LESS
goods
IG: Income
RISES =
LESS** goods
PERFECT SUBSTITUTES.
Example: BUTTER and MARGARINE can be substitute perfectly as it has
similar function
Similar function
or
property
that can be substitute perfectly
Goods or services that can be
substitute
perfectly
OPTIMUM LEVEL.
INDIFFERENCE CURVES (IC)
BUDGET CONSTRAINT (BC)
IC must be
TANGENT
to BC at any point