Indifference curves / Budget lines Flashcards
What does the indifference curve show?
Preferences, based on utility
What does the budget line show?
Prices
What is a composite good?
All other goods or services
What is utility?
Satisfaction
When is a consumer indifferent?
Where two bundles of goods provide the same level of utility (satisfaction) for a consumer, the consumer is indifferent between the two bundles.
(They don’t care which one they have)
What is the marginal rate of substitution?
Willingness to give up good Y (y axis) for an additional unit of good X (x axis)
- What you give up / what you gain
As a good becomes more scarce…
The utility for the good increases (your willingness to give up the good gets less and less)
(vice versa - as a good becomes less scarce, utility decreases)
What shape is the indifference curve?
Convex
Marginal rate of substitution decreases as we move along the curve
What happens if you get a good for free?
- You have more utility, you have gained but haven’t had to give up
- You will need to shift to a new (higher) indifference curve (more preferred)
Does an indifference curve shift?
No, you move to a higher indifference curve
What is / How is a perfect substitute seen on an indifference curve?
The consumer doesn’t care about the difference / cares equally about each good
- Straight line because utility lost is equal to utility gained
- Price of exchange / ratio doesn’t change 1:1
What is / How is a perfect compliment seen on an indifference curve?
No matter how many of one more someone gives you, you don’t gain more utility
- You have to consume the goods in pairs / together
- Therefore curves are L shaped, each curve moving further upward / outward
- Perfect compliments must be consumed in the same ratio. (1:1 - 1left and 1 right shoe, has the same utility as 1 left and 2 right shoes)
What are the two indifference curve rules?
- Indifference curves don’t cross (can’t intersect)
- It doesn’t make sense that one combination of goods can be on two different curves with different levels of utility- Indifference curves can’t be too curvy
- With a horizontal or vertical line it should only intersect the indifference curve at one point
- Indifference curves can’t be too curvy
What do budget lines tell us?
the highest bundle a consumer can afford
Issues with points inside or outside the budget line
Any point inside the budget line = not all income is spent
Any point outside the budget line = unaffordable
Which bundle will a utility maximizing consumer consume?
A utility maximizing consumer will consume a bundle on the highest possible indifference curve, where all income is spent (point on the budget line)
- Where the indifference curve is tangent (one intersect) to the budget line
How is the slope of the budget line expressed?
- (price of good x) / (price of good y)
(generally ignore the negative)
Where is the point of consumption?
Where the indifference curve is tangent to the budget line
Which good would we want to buy?
We want to buy the good that gives us the most utility per dollar spent
How does utility fall for a good? What occurs when this happens?
As a consumers buys more of one good, their utility will start to fall
(start to get sick of the good)
This will continue until the utility per dollar spent on Good A = the utility per dollar spent on Good B
- The consumer is indifferent between the goods at this point
What is the tangency condition?
optimal bundle is where the marginal utility per dollar spent is the same for both goods
What happens to BL / I with an increase in income?
budget line shifts outward (higher budget), shift to a higher indifference curve
- Points that were once outside the budget line are now attainable ○ Budget lines are parallel, as prices have not changed
(We are assuming both goods are normal goods, so the Qd increases as income increases)
What happens to BL / I with a decrease in income?
budget line would shift inward, consumer would move to a lower indifference curve
What happens to BL / I with INFERIOR goods and a decrease in income?
Budget line decreases
The indifference curve is lower but shifts upward towards the inferior good section of the line
- buy more inferior goods when we have lower income
- Indifference curve contains more of the inferior good
(opposite for an increase in income)
On the indifference / Budget line what are the axis??
Both axis are quantity
How do you calculate points on the axis of BL/I?
income / price of good (x or y)
What happens when the price changes of one good?
- As P of Y increases, the consumer can only afford a smaller quantity of good Y
- The X axis is unaffected
- The consumer moves to a lower indifference curve tangent to the new budget line
- The bundles of goods on the original indifference curve are now unaffordable
○ They now have less utility -
are worse off
(If the price decreased the y axis intercept would be higher, the consumer would move to a higher indifference curve / budget line)
What do community service cards do?
makes the price of medical services decrease (composite good) - Consumers can afford to buy more
- an increase in the quantity of medical services and a small increase in the quantity of the composite good
- The y axis intercept has increased, x axis hasn’t changed
Consumer can now consume bundle on a higher indifference curve tangent to the new budget line
- The y axis intercept has increased, x axis hasn’t changed
- people may go to the doctor when they don’t need to - govt must pay more subsidies
What do we mean by composite goods?
All other goods and services
What do govt cash beneficiaries do?
BL shifts outward for both y and x axis
- Both policies make the consumer equally as well off (same utility) - Both are government - use of tax payers funds
The consumer who doesn’t need lots of medical services will prefer this option
- can get higher indifference curves towards good x
- could be spent innapropriatley
