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Chapter 8
Appendix
INDIFFERENCE CURVE
ANALYSIS
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
8A-2
Sophie’s Choice
• Given her budget constraint, Sophie
•
•
wants to maximize the utility she gets
from drinking sodas and eating
chocolate bars.
Chocolate bars cost $1 and sodas cost
50 cents, and she has $10 to spend.
She can buy 10 chocolate bars or 20
sodas or some combination of the two.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
8A-3
Graphing the Budget Constraint
Sophie has $14
to spend.
Price of
soda is $1.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
8A-4
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
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.
Indifference curves are downward sloping and
bowed inward.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
8A-5
Graphing the Indifference Curve
MUsoda
Slope 
 Marginal rate of substituti on
MUchocolate
• Law of diminishing marginal rate of
substitution – as you get 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.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
8A-6
Graphing the Indifference Curve
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
8A-7
A Group of Indifference Curves
•
•
McGraw-Hill/Irwin
Sophie will have a
whole group of
indifference curves,
each representing a
different level of
satisfaction.
If she prefers more to
less, she is better off
with the indifference
curve that is farthest to
the right.
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
8A-8
Why Indifference Curves
Cannot Cross
If indifference
curves crossed,
it would violate
the “prefermore-to-less”
principle.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
8A-9
Indifference Curves and
Budget Constraints
•
•
Sophie will maximize her utility by consuming on the
highest indifference curve as possible, given her
budget constraint.
The best combination is the point where the slope of
the budget line equals the slope of the indifference
curve.
Ps MUs

Pc MUc
McGraw-Hill/Irwin
so that
MUc MUs

Pc
Ps
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
8A-10
Indifference Curves and
Budget Constraints
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
8A-11
Deriving a Demand Curve from
the Indifference Curve
• Demand is the quantity of a good that a
•
person will buy at various prices.
By varying the price of one of the goods
while holding the price of the other
constant, the alternative price/quantity
combinations of the demand curve can
be found.
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.
8A-12
Deriving a Demand Curve from
the Indifference Curve
McGraw-Hill/Irwin
Copyright  2006 by The McGraw-Hill Companies, Inc. All rights reserved.