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EC111LectNG3

EC111LectNG3 - University of Essex Department of Economics...

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1 University of Essex Session 2011/2012 Department of Economics Autumn Term EC111: INTRODUCTION TO ECONOMICS THE THEORY OF CONSUMER CHOICE Individuals choose to consume a combination of different goods. The choice depends on the individual’s preferences and his or her budget constraint. Consumer preferences There are many goods and the consumer chooses a bundle (or combination) of quantities. Here we simplify to two goods, good X and good Y. Goods yield satisfaction to the consumer, we shall call it ‘utility’. The consumer can rationally compare and rank different combinations in terms of utility. (This is what we mean by preference). Utility is ordinal rather than cardinal: we do not require the consumer to say how much one bundle is preferred to another. The individual can rank two (different) bundles as equal in utility. We say that the consumer is indifferent between the two bundles The quantity of X is measured along the horizontal axis; the quantity of Y along the vertical axis. The consumer is indifferent between bundle A and bundle B: they are on the same indifference curve, U 1 . U 2 represents a higher level of utility than U 1 . B A q Y q X U 2 U 1

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2 Indifference curves have three properties: They slope down They don’t cross They are convex to the origin They are derived from three axioms: 1) Non-satiation (monotonicity): more is preferred to less Combination B is preferred to combination A, because it contains more of both goods (they cannot be on the same indifference curve). Combination C is inferior to A because it has less of both goods. Combination D must be preferred to A because it contains more of Y and the same amount of X. So indifference curves must slope down We cannot be sure whether E is preferred to A because it has more Y but less X (but they could be on the same indifference curve). D A q X q Y C B E
2) Transitivity Suppose the consumer is indifferent between A and C. The consumer prefers B to C (because it has more X). The consumer must therefore prefer B to A. This means indifference curves cannot cross; the dotted curve is not legitimate. Combination B must lie on an indifference curve which is everywhere above the indifference curve passing through C. Note that in difference curve maps will be not be the same for different individuals.

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EC111LectNG3 - University of Essex Department of Economics...

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