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Lecture5 - LECTURE 5 Indifference Curves Theory Some...

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LECTURE 5: Indifference Curves Theory S ti Some assumptions… 1. Axioms of Consumer Behaviour RATIONALITY: The consumer acts in such a manner as to maximize total utility RATIONALITY: The consumer acts in such a manner as to maximize total utility. COMPLETE ORDERING: The consumer is able to rank all available bundles of commodities by order of preference or indifference. They need not know by how much a bundle is preferred to another (this is a simple ordinal ranking). CONSISTENCY: The consumer’s ranking of bundles is free from contradictions. Let the symbol for “preferred to” be “ ” (note that this is not the “greater than” symbol) and the symbol for “indifferent to” be “ ~ ”. For example, if the consumer h th h i b t t dit b dl X d Y th has the choice between two commodity bundles, X and Y, then if X › Y then Y › X cannot occur. if X ~ Y then X › Y cannot occur. TRANSITIVITY: The consumer’s ranking of bundles must be transitive. For example, if X › Y and Y › Z then X › Z must be true. Suppose that I like tea better than coffee and that I like coffee better than orange juice; then it must be true that I like tea better than orange juice.
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1. Axioms of Consumer Behaviour (continued) NONSATIATION: The consumer prefers “more” to “less”. Y Suppose we have two goods X and Y A B Preferred to bundle A Suppose we have two goods, X and Y. A bundle of X and Y is preferred to another if it has as many of each, and more of at least one of the commodities. X A C So, is bundle B preferred to bundle A? YES! There is the same amount of X in bundle B and bundle A, but there is more of good Y in bundle B so the consumer prefers good Y in bundle B…so the consumer prefers bundle B to bundle A (B › A). Is bundle C preferred to bundle A? We have no real way of knowing…bundle C may or may not be preferred to bundle A. Why can’t we tell? There is more X in bundle C than in bundle A, but there is less Y in bundle C than in bundle A. Since we do not know the strength (or magnitude) of the consumer’s preferences for X and Y, we have no way of knowing the net effect of having more X and less Y in bundle C.
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2. Definition and Derivation of Indifference Curves The idea is to express the individual’s pattern of preferences by connecting all bundles for which he or she has expressed indifference. Y A ~ B since they are on the same indifference IC b tt IC 3 more better A C E curve (similarly, C ~ D ). C › A and C › B and D › A and D › B. This result stems from the fact that bundles C X IC 1 good 2 better B D and D are on a higher indifference curve than bundles A and B (similarly, E is preferred to A, B, C and D). Essentially, we define indifference curves as the locus of commodity bundles that give the consumer the same level of “satisfaction” or total utility (TU). For each level of TU there is a separate indifference curve. Since the consumer is assumed to prefer “more” to “less” we assign higher “orders” of preference to indifference curves that are further from the origin.
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