ECON_2306 => Lecture 5B Slides

ECON_2306 => Lecture 5B Slides - L5B: Consumer...

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1 L5B: Consumer Behavior and Utility Maximization (Ch 7) Indifference Curve Analysis Ordinal Utility An ordinal utility function does not require precise measurement of actual utility received from a good or service It requires only that consumers be able to state whether they prefer one combinations of goods to another or are indifferent between them Assumptions A consumer who is indifferent between two sets of goods likes them both equally well; they both yield the same amount of Principles of Microeconomics, SP 2010 3 satisfaction. Consumers are consistent in their rankings (if you prefer 3 hamburgers to 4 tacos but you prefer 4 tacos to 2 hotdogs, then you must also prefer 3 hamburgers to 2 hotdogs. Consumers prefer more to less of a good in the relevant range of choice. If someone offered you a choice between 2 hamburgers and 3 hamburgers for free, you would always choose 3 hamburgers. How do we construct the ordinal utility function? How do we construct the ordinal utility function? Consumers will tell us how she or he would rank combinations of goods and services in order of preference and we then can assign utility numbers to these combinations. Principles of Microeconomics, SP 2010 4 After the consumers’ utility function has been constructed, we can draw indifference curves, which shows various combinations of 2 goods or services about which a consumer is indifferent.
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2 INDIFFERENCE CURVES Indifference curves show all combinations of two products that will yield the same level of satisfaction or utility to the consumer. Indifference curve must have a negative slope. Why? Consumers always prefer more to less of a good If some of one good is given up, more of the second good Principles of Microeconomics, SP 2010 5 must be obtained for the consumers to remain at the same level of satisfaction or vice versa. Indifference curves cannot intersect. If they did intersect, that would mean that the combination of goods and services at the point of intersection gave a consumer two different levels of utility, which is impossible. INDIFFERENCE CURVES Higher (farther to the right) indifference curves must represent higher levels of utlity. I2 must represent a higher level of satisfaction than does I1, because I2 represents a combination of goods A and B that contains more of both goods than I1. The following figure shows two indifference curves for Principles of Microeconomics, SP 2010 6 combinations of product A and product B. Each indifference curve represent a different level of utility Point J, for instance, indicates that this consumer is indifferent between 12 A and 2 B Point K, indicates that this consumer is indifferent between 6 A and 4 B. INDIFFERENCE CURVES What is Preferred y of A 12 10 8 Units of A Price $1.50 Units of B Price $1.00 Total Expenditures 8 0 $12 6 3 12 4 6 12 2 9 12 j Principles of Microeconomics, SP 2010 7 Quantity Quantity of B 6 4 2 0 2 4 6 8 10 12 0 12 12 An Indifference Schedule Combi- nation Units of A Units of B j 12 2 12 10 8 Units of A Price $1.50 Units of B Price $1.00 Total Expenditures 8 0 $12 6 3 12
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ECON_2306 => Lecture 5B Slides - L5B: Consumer...

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