2.2. Indifference Curves and Budget Lines

Question 1

Indifference Curve

Answer 1

A line showing all the different combination of two goods that give a consumer equal utility.
- A consumer would be indifferent to any of these combinations.

Question 2

Indifference

Answer 2

If you accuse someone of beingindifferentto something, youmeanthat they have a complete lack of interest in it

Question 3

How indifference is shown on indifference curves

Answer 3

• Indifference can be show on an indifference curve.
• An indifference curve is a graph showing combination of two goods that give the consumer equal satisfaction and utility.
• Each point on an indifference curve indicates that a consumer isindifferent between the two and all points give him the same utility.

Question 4

Indifference curve features

Answer 4

• The slope of the indifference curve represents the marginal rate of substitution
• Higher indifference curves represent higher levels of consumption
• All indifference curves are downward sloping
• Indifference curves cannot cross
• Indifference curves are concave

Question 5

Any point above the indifference curve refers to

Answer 5

preferred consumption - where you get more of at least one good

Question 6

Any point below the indifference curve refers to

Answer 6

less preferred consumption - you get less of goods so you are worse off

Question 7

Marginal rate of substitution

Answer 7

measures the rate at which you are willing to forgo one good in order to get one more of another good, while keeping utility constant

Question 8

How to find marginal rate of substitution on indifference curves

Answer 8

draw tangents to the curve and see how much of one good you are willing to give up

Question 9

Why does marginal rate of substitution fall as you consume more of a good

Answer 9

law of diminishing marginal utility

• the more you consume something the less marginal utility you receive
• as you lose more of a good, its marginal utility increases

Question 10

Indifference curve of perfect substitutes

Answer 10

• be equally happy when you consume more of one good and less of another
• constant marginal rate of utility
• marginal rate of substitution = 1
• straight, down sloping line

Question 11

Indifference curve of perfect complements

Answer 11

• etc. 1 hotdog bun and 1 hotdog
• you always want 1 for 1
• indifference curves would look like right angles
• most preferred combination at the right angle - lowest point of curve

Question 12

Indifference curves farther to the right means

Answer 12

higher utility gained
- a rational consumer will therefore choose to be on the furthest out indifference curve that they can afford to be on (i.e. given their income / budget).

Question 13

Indifference curves for demerit goods

Answer 13

• convex curves

- less satisfaction when indifference curve is higher

Question 14

Why can’t indifference curves intersect

Answer 14

• If they are allowed to cross, we are saying that the combination of goods at the intersection point, represents at the same time, different levels of utility
• makes no sense

Question 15

Indifference curves for unrelated goods

Answer 15

• For unrelated goods, the indifference curve is either vertical or horizontal.
• Vertical means consumer only cares about X-axis (diamonds) and has no satisfaction from Y-axis (paint).
• Total utility does not change when more paint (Y-axis) is consumed.
• Vice versa for horizontal

Question 16

Budget Lines

Answer 16

A line showing all the combinations of two products a consumer would be able to purchase with fixed prices and a given income.
- Reveals opportunity cost

Question 17

What do Budget Lines reveal?

Answer 17

Relative prices:
- Price of 1 coffee is 2 teas.
- Price of 1 tea is 0.5 coffees.
Opportunity cost: 
- Opp cost of 1 coffee is 2 teas.
- Opp cost of 1 tea is 0.5 coffees

Question 18

Changes in price for budget lines

Answer 18

• Increase in price –> shift down of budget lines

- decrease in price –> shift up of budget lines

Question 19

Changes in income (budget) for budget lines

Answer 19

• increase in income –> shift up of budget lines

- decrease in income –> shift down of budget lines