View
32
Download
0
Category
Tags:
Preview:
DESCRIPTION
PPA 723: Managerial Economics. Lecture 5: Indifference Curves. Managerial Economics, Lecture 5: Indifference Curves. Outline Properties of Consumer Preferences Indifference Curves. Managerial Economics, Lecture 5: Indifference Curves. Tastes. - PowerPoint PPT Presentation
Citation preview
PPA 723: Managerial Economics
Lecture 5:
Indifference Curves
Managerial Economics, Lecture 5: Indifference Curves
Outline
Properties of Consumer Preferences
Indifference Curves
Managerial Economics, Lecture 5: Indifference Curves
TastesIndividual tastes (preferences)
determine the pleasure people derive from different goods and services
Our objective is to determine how a consumer’s tastes influence its decisions (positive analysis), not to judge tastes (normative).
Managerial Economics, Lecture 5: Indifference Curves
Standard Assumptions About Consumer Preferences
1. Completeness
2. Transitivity
3. More is better
Managerial Economics, Lecture 5: Indifference Curves
Assumption 1: Completeness
Consumer can rank any two bundles of goods
Only one of the following is true: The consumer prefers Bundle x to Bundle yprefers Bundle y to Bundle xis indifferent between the two bundles
Managerial Economics, Lecture 5: Indifference Curves
Assumption 2: Transitivity (Rationality)
A consumer's preference over bundles is consistent:
If a consumer prefers Bundle z to Bundle y and Bundle y to Bundle x
Then that consumer prefers Bundle z to Bundle x
Managerial Economics, Lecture 5: Indifference Curves
Assumption 3: More is BetterMore of a good is better than less of it.
Good: commodity for which more is preferred to less at least at some levels of consumption
Bad: something for which less is preferred to more, such as pollution
Consumers are not satiated.
Managerial Economics, Lecture 5: Indifference Curves
Figure 4.1a Bundles of Pizzas and Burritos Lisa Might Consume
B, Burritosper semester
(a) Ranking Regions
302515
Z, Pizzas per semester
25
20
15
10
0
da
b
e
c
f
A
B
Managerial Economics, Lecture 5: Indifference Curves
Figure 4.1b Bundles of Pizzas and Burritos Lisa Might Consume
B, Burritosper semester
(b) Indifference Curve
302515
Z, Pizzas per semester
25
20
15
10
0
da
bI
e
c
f
Managerial Economics, Lecture 5: Indifference Curves
Figure 4.1c Bundles of Pizzas and Burritos Lisa Might Consume
B, Burritosper semester
(c) Preference Map
302515
Z, Pizzas per semester
25
20
15
10
0
d
I0
I 1
I 2
e
c
f
Managerial Economics, Lecture 5: Indifference Curves
Indifference Curve Properties
1. Bundles on indifference curves farther from the origin are preferred to those on indifference curves closer to the origin.
2. There is an indifference curve through every possible bundle.
3. Indifference curves cannot cross.4. Indifference curves are “thin”.5. Indifference curves slope down.
Managerial Economics, Lecture 5: Indifference Curves
Figure 4.2a Impossible Indifference Curves
B, Burritosper semester
(a) Crossing
Z, Pizzas per semester
I 1
I0a
be
Managerial Economics, Lecture 5: Indifference Curves
Figure 4.2b Impossible Indifference Curves
B, Burritosper semester
(b) Upward Sloping
Z , Pizzas per semester
I
a
b
Managerial Economics, Lecture 5: Indifference Curves
Willingness to Substitute
Downward-sloping indifference curve consumer is willing to substitute one good for the other.
Marginal rate of substitution (MRS) of burritos (rise) for pizza (run), is slope of indifference curve:
BMRS
Z
Managerial Economics, Lecture 5: Indifference Curves
B , Burritosper semester
Z, Pizzas per semester
I
B
Z
MRS = B/Z
Marginal Rate of Substitution
Managerial Economics, Lecture 5: Indifference Curves
MRS Varies Along an Indifference Curve
Indifference curves bow away from the origin (called convex).
Indicates diminishing marginal rate of substitution (MRS).
Managerial Economics, Lecture 5: Indifference Curves
Figure 4.3a Marginal Rate of Substitution
B , Burritosper semester
(a) Indifference CurveConvex to the Origin
5
3
8
1–1
1
12
0
–2
–3
3 4 5 6
Z , Pizzas per semester
a
b
c
d
I
Managerial Economics, Lecture 5: Indifference Curves
Unlikely Outcome:Concave Indifference Curve
If indifference curve bows toward the origin (concave),
Then (implausibly) the consumer has an increasing MRS.
Managerial Economics, Lecture 5: Indifference Curves
Figure 4.3b Marginal Rate of Substitution
B, Burritosper semester
(b) Implausible Indifference Curvethat is Concave to the Origin
5
7
1
1
2
0
–2
–3
3 4 5 6
Z, Pizzas per semester
a
b
c
I
Managerial Economics, Lecture 5: Indifference Curves
Figure 4.4a Perfect Substitutes
Coke, Cansper week
1 2 3 4
Pepsi, Cans per week
1
0
2
3
4
I 1 I2 I3 I 4
Managerial Economics, Lecture 5: Indifference Curves
Figure 4.4b Perfect Complements
Ice cream,Scoops per week
1 2 3
Pie, Slices per week
1
2
3
0
I 1
I 2
I 3
a
d
e c
b
Managerial Economics, Lecture 5: Indifference Curves
Figure 4.4c Imperfect Substitutes
B , Burritosper semester
Z, Pizzas per semester
I
Managerial Economics, Lecture 5: Indifference Curves
Utility Utility is a number that reflects the relative
rankings of various bundles of goods
If Lisa prefers bundle A to B, then utility from A must be greater than utility from B
A utility function is a: relationship between a utility measure and every
possible bundle of goodsuccinct summary of information in an indifference
curve map
Managerial Economics, Lecture 5: Indifference Curves
Utility and Marginal Utility
The marginal utility of Z is:
MUZ is the change in utility from a small increase in Z holding B fixed
Z
UMU
Z
Managerial Economics, Lecture 5: Indifference Curves
U , Utils
U = 20
Utility function, U (10, Z )
Z = 1
10987654321
Z , Pizzas per semester
0
350
250
Utility
230
Managerial Economics, Lecture 5: Indifference Curves
, MarginalMUZ utility of pizza
MUZ
10987654321
Z, Pizzas per semester
0
130
Marginal Utility
20
Managerial Economics, Lecture 5: Indifference Curves
Economic analysis often depends on the distinction between a total, a average, and a margin.
In the case of utility U = total utility U/Z = average utility of Z MUZ = U/Z = marginal utility of Z
Totals, Margins, and Averages
Managerial Economics, Lecture 5: Indifference Curves
Utility and the Marginal Rate of Substitution
Let A = the good on the vertical axis and B = the good on the horizontal axis,
Then (note the inversion):
A
BA
MU
US
BMR
M
Managerial Economics, Lecture 5: Indifference Curves
I
Give upone unit
of A
B
MRS = A/B = - MUB/MUA
Marginal Rate of Substitution
Quantity of A
Quantity of B
Gain MUA units of utility,which can “buy”
MUA / MUB Units of B
A
Managerial Economics, Lecture 5: Indifference Curves
0 ( ) ( )
( )A B
A B
U A MU B MU
MU B MU
A
B
MUB
MU
1
/B
A B A
MUAMRS
B MU MU MU
Deriving the Marginal Rate of Substitution
Recommended