Partial and general equilibrium, law of demand and demand analysis
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- Examples of Indifference Curves
AssumptionsLet a, b, and c be bundles (vectors) of goods, such as (x, y) combinations above, with possibly different quantities of each respective good in the different bundles. The first assumption is necessary for a well-defined representation of stable preferences for the consumer as agent; the second assumption is convenient. Rationality (called an ordering relationship in a more general mathematical context): Completeness + transitivity. For given preference rankings, the consumer can choose the best bundle(s) consistently among a, b, and c from lowest on up. Continuity: This means that you can choose to consume any amount of the good. For example, I could drink 11 mL of soda, or 12 mL, or 132 mL. I am not confined to drinking 2 liters or nothing. See also continuous function in mathematics. Of the remaining properties above, suppose, property (5) (convexity) is violated by a bulge of the indifference curves out from the origin for a particular consumer with a given budget constraint. Consumer theory then implies zero consumption for one of the two goods, say good Y, in equilibrium on the consumer's budget constraint. This would exemplify a corner solution. Further, decreases in the price of good Y over a certain range might leave quantity demanded unchanged at zero beyond which further price decreases switched all consumption and income away from X and to Y. The eccentricity of such an implication suggests why convexity is typically assumed. Examples of Indifference CurvesIn Figure 3, the consumer would rather be on I3 than I2, and would rather be on I2 than I1, but does not care where he/she is on a given indifference curve. The slope of an indifference curve (in absolute value), known by economists as the marginal rate of substitution, shows the rate at which consumers are willing to give up one good in exchange for more of the other good. For most goods the marginal rate of substitution is not constant so their indifference curves are curved. The curves are convex to the origin, describing the negative substitution effect. As price rises for a fixed money income, the consumer seeks less the expensive substitute at a lower indifference curve. The substitution effect is reinforced through the income effect of lower real income (Beattie-LaFrance). If two goods are perfect substitutes then the indifference curves will have a constant slope since the consumer would be willing to trade at a fixed ratio. The marginal rate of substitution between perfect substitutes is likewise constant. An example of a utility function that is associated with indifference curves like these would be If two goods are perfect complements then the indifference curves will be L-shaped. An example would be something like if you had a cookie recipe that called for 3 cups flour to 1 cup sugar. No matter how much extra flour you had, you still could not make more cookie dough without more sugar. Another example of perfect complements is a left shoe and a right shoe. The consumer is no better off having several right shoes if she has only one left shoe. Additional right shoes have zero marginal utility without more left shoes. The marginal rate of substitution is either zero or infinite. An example of the type of utility function that has an indifference map like that above is The different shapes of the curves imply different responses to a change in price as shown from demand analysis in consumer theory. The results will only be stated here. A price-budget-line change that kept a consumer in equilibrium on the same indifference curve: in Fig. 3 would reduce quantity demanded of a good smoothly as price rose relatively for that good. in Fig. 4 would have either no effect on quantity demanded of either good (at one end of the budget constraint) or would change quantity demanded from one end of the budget constraint to the other. in Fig. 5 would have no effect on equilibrium quantities demanded, since the budget line would rotate around the corner of the indifference curve.
Figure 4: Three indifference curves where Goods X and Y are perfect substitutes. The gray line perpendicular to all curves indicates the curves are mutually parallel. 
Figure 5: Indifference curves for perfect complements X and Y. The elbows of the curves are collinear. 3.5 Revealed preference Revealed preference theory, pioneered by American economist Paul Samuelson, is a method by which it is possible to discern the best possible option on the basis of consumer behavior. Essentially, this means that the preferences of consumers can be revealed by their purchasing habits. Revealed preference theory came about because the theories of consumer demand were based on a diminishing marginal rate of substitution (MRS). This diminishing MRS is based on the assumption that consumers make consumption decisions based on their intent to maximize their utility. While utility maximization was not a controversial assumption, the underlying utility functions could not be measured with great certainty. Revealed preference theory was a means to reconcile demand theory by creating a means to define utility functions by observing behavior. Directory: sim sim -> Simon Mckeown Artist C. V. DaDaFest International Artist of the Year 2010 sim -> Viii seb extended Abstracts Sample File: Note Initial Caps sim -> Simscript III release 0 May 23th, 2016 sim -> Concepts and terminology in the Simula Programming Language sim -> Stormwind navigation simulator, which won the Open Data Innovation Contest Apps4Finland in 2013 sim -> Multiscale Simulation Representative publications sim -> United Nations Development Programme Country: Solomon Islands Project Document sim -> Antecedent, antebellum, ante meridian sim -> A simulated Hallucination Mechanism Compared to Hallucination Brain Response Studies Download 0.63 Mb. Share with your friends:
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