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Indifference Curve AnalysisIndifference Curve Analysis
Chapter 8 Appendix
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Sophies ChoiceSophies Choice Sophie eats chocolate bars and drinks
soda.
She wants to maximize her utility given abudget constraint.
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Graphing the BudgetGraphing the Budget
ConstraintConstraint Chocolate bars cost $1 and sodas cost 50
cents each.
Sophie has $10 to spend.
She can buy 10 chocolate bars or 20sodas or some combination of each.
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Graphing the BudgetGraphing the Budget
ConstraintConstraint
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Graphing the BudgetGraphing the Budget
ConstraintConstraint The slope of the budget constraint is the
ratio of the prices of the two goods.
The slope changes when the priceschange.
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Graphing the IndifferenceGraphing the Indifference
CurveCurve Indifference curve a curve that shows
combinations of goods among which an
individual is indifferent.
The slope of the indifference curve is theratio of marginal utilities of the two goods.
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Graphing the IndifferenceGraphing the Indifference
CurveCurve The absolute value of the slope of an
indifference curve is called the marginal
rate of substitution.
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Graphing the IndifferenceGraphing the Indifference
CurveCurve Marginal rate of substitution the rate at
which one good must be added when the
other is taken away in order to keep theindividual indifferent between the twocombinations.
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Graphing the IndifferenceGraphing the Indifference
CurveCurve Indifference curves are downward sloping
and bowed inward.
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Graphing the IndifferenceGraphing the Indifference
CurveCurve Lawof diminishing marginal rate of
substitution as you get more and more
of a good, if some of that good is takenaway, then the marginal addition of anothergood you need to keep you on your
indifference curve gets less and less.
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Graphing the IndifferenceGraphing the Indifference
CurveCurve
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A Groupof IndifferenceA Groupof Indifference
CurvesCurves Sophie will have a whole group of
indifference curves, each representing a
different level of happiness.
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A Groupof IndifferenceA Groupof Indifference
CurvesCurves 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 Groupof IndifferenceA Groupof Indifference
CurvesCurves
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Why Indifference CurvesWhy Indifference Curves
Cannot CrossCannot Cross If indifference curves crossed, it would
violate the prefer-more-to-less principle.
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Why Indifference CurvesWhy Indifference Curves
Cannot CrossCannot Cross
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Indifference Curves andIndifference Curves and
Budget ConstraintsBudget Constraints Sophie will maximize her utility by
consuming on the highest indifference
curve as possible, given her budgetconstraint.
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Indifference Curves andIndifference Curves and
Budget ConstraintsBudget Constraints The best combination is the point where
the indifference curve and the budget line
are tangent.
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Indifference Curves andIndifference Curves and
Budget ConstraintsBudget Constraints The best combination is the point where
the slope of the budget line equals the
slope of the indifference curve.
S
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Indifference Curves andIndifference Curves and
Budget ConstraintsBudget Constraints
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Deriving a Demand CurveDeriving a Demand Curve
from the Indifference Curvefrom 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 CurveDeriving a Demand Curve
from the Indifference Curvefrom 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 givenprice.
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Deriving a Demand CurveDeriving a Demand Curve
from the Indifference Curvefrom 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/quantitycombinations.
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Deriving a Demand CurveDeriving a Demand Curve
from the Indifference Curvefrom the Indifference Curve
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Indifference Curve AnalysisIndifference Curve Analysis
End of Chapter 8 Appendix