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Indifference Curve Analysis
Chapter 8 Appendix
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Sophie’s Choice
Sophie eats chocolate bars and drinks
soda.
 She wants to maximize her utility given a
budget constraint.

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Graphing the Budget
Constraint
Chocolate bars cost $1 and sodas cost 50
cents each.
 Sophie has $10 to spend.
 She can buy 10 chocolate bars or 20
sodas or some combination of each.

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Graphing the Budget
Constraint
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Graphing the Budget
Constraint
The slope of the budget constraint is the
ratio of the prices of the two goods.
 The slope changes when the prices
change.

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Graphing the Indifference
Curve
Indifference curve – a curve that shows
combinations of goods among which an
individual is indifferent.
 The slope of the indifference curve is the
ratio of marginal utilities of the two goods.

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Graphing the Indifference
Curve

The absolute value of the slope of an
indifference curve is called the marginal
rate of substitution.
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Graphing the Indifference
Curve

Marginal rate of substitution – the rate at
which one good must be added when the
other is taken away in order to keep the
individual indifferent between the two
combinations.
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Graphing the Indifference
Curve

Indifference curves are downward sloping
and bowed inward.
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Graphing the Indifference
Curve

Law of diminishing marginal rate of
substitution – as you get more and more
of a good, if some of that good is taken
away, then the marginal addition of another
good you need to keep you on your
indifference curve gets less and less.
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Graphing the Indifference
Curve
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A Group of Indifference
Curves

Sophie will have a whole group of
indifference curves, each representing a
different level of happiness.
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A Group of Indifference
Curves

If she prefers more to less, she is better off
with the indifference curve that is farthest
to the right.
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A Group of Indifference
Curves
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Why Indifference Curves
Cannot Cross

If indifference curves crossed, it would
violate the “prefer-more-to-less” principle.
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Why Indifference Curves
Cannot Cross
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Indifference Curves and
Budget Constraints

Sophie will maximize her utility by
consuming on the highest indifference
curve as possible, given her budget
constraint.
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© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Indifference Curves and
Budget Constraints

The best combination is the point where
the indifference curve and the budget line
are tangent.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Indifference Curves and
Budget Constraints

The best combination is the point where
the slope of the budget line equals the
slope of the indifference curve.
PS MUS
MUC MUS

so that

PC MUC
PC
PS
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© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Indifference Curves and
Budget Constraints
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Deriving a Demand Curve
from the Indifference Curve

Demand is the quantity of a good that a
person will buy at various prices.
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Deriving a Demand Curve
from the Indifference Curve

The point of tangency of the indifference
curve and the budget line gives the
quantity that a person would buy at a given
price.
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Deriving a Demand Curve
from the Indifference Curve
By varying the price of one of the goods
while holding the price of other constant,
the points of tangency will change.
 This gives alternative price/quantity
combinations.

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© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.
Deriving a Demand Curve
from the Indifference Curve
McGraw-Hill/Irwin
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Indifference Curve Analysis
End of Chapter 8 Appendix
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc., All Rights Reserved.