hi guys this is day three of the 30 day a to economics revision challenge and today we're doing indifference curve when we look at utility theory to look at consumer choice and find out the combination which can give a consumer the maximum possible satisfaction from a given income which is the primary goal of consumers to you'd maximize his utility the problem that happened with the utility theory was to style the utility jury assumes that we can measure we can measure utility now in reality this is not true in reality we cannot measure utility and that becomes a big problem a big challenge when it comes to the equal marginal principle so we need to find the theory which is more realistic in terms of looking at consumer choice and that's where indifference curve comes indifference curve is based on the principle that you know like we cannot measure utility but we could definitely we can definitely rank rank different combinations so for example if you ask me do I like at those more than oranges and my answer will be yes for example and if you ask me by how much my answer will be I don't know but if I could do ranking then basically by finding by ranking combinations we can actually build a consumer theory or we can build sort of preference structures so our goal is to look at preference structure we like this preference structure through true ranking let's now talk about the definition of indifference curve so what is the difference curve indifference curve is simply all the various combinations of two goods that give an equal amount of satisfaction or utility so if I'm a consumer if there is an indifference curve of two birds all the various combinations that are on that indifference curve I am ranking them equally in terms of utility no one combination that same indifference curve will have a higher utility so let's see an example let's say I have two Goods apples and oranges and I am looking at the indifference curve structure for those so on my x-axis I have apples and on my y-axis let's say I have quantity of so apples quantity of oranges and if I'm saying that there is an indifference curve out there let's say indifference curve I not where you have all the combinations like combination a or combination B or any combination let's say C D or even E all these combinations are giving us the same satisfaction or utility and that means that I am indifferent when I am choosing between these combinations so there is no no preference over let's say one over another let's give some values to this combination let's say a is let's say thirty of oranges and so for example six of apples and on the other hand B is like six seven of apples while 24 oranges now what you see is this I'm saying that if I choose 30 oranges and six apples versus 24 oranges and seven apples I am indifferent which means that I have no clear sort of preference when it comes to a and B similarly if I go all the way to like fill sample D which is like let's say ten of sort of oranges and 13 of apples and vice versa e which is 8 of sort of oranges and 15 of apples I am indifferent so all points on the indifference curve this consumer or I am indifferent and that's why it's got a different stuff now one more concept that we want to talk about before we move on is what are the way is sort of characteristics of indifference curve or what are the way is the sort of principles I mean you remember when we are drawing an indifference curve now let's talk about the characteristics of indifference curve the first characteristic of indifference is that we want to discuss is the idea that all combinations have all combinations have a utility level and we can rank them the fact that we can rank in sort of different combinations that ability to do so means we can draw indifference curves if I tell you that there is no way we can figure out the ranking of combinations then this means we cannot draw indifference curve so the fact that we could rank combinations is the reason why we can draw indifference curve the second one that we want to discuss when it comes to the characteristics is the idea that more is better more is better is the idea that we say that any indifference curve that is to the right which means let's say I draw a diagram here any indifference curve which is to the right is more is better it's true then any indifference curve to the right will result in higher utility so let's say this is oranges or my x-axis and apples and let's say I am right now on indifference I nod but if more is better this means any indifference curve to the right like for example this indifference curve I 1 will always result in a better sort of satisfaction or utility level which means that more is better means as if this was 30 and for example 7 and now for every 30 I can get for example 10 oranges this means indifference curve to the right is always preferred over indifference curve to the left or indifference curve to the right will have a higher utility level than 1 or the left because by without sacrificing anything of apples I'm getting more of oranges which means indifference curve to the right or eye one is better than I not and I can write that more is better means that any indifference curve to the right is resulting in higher utility and if it is resulting in higher utility that definitely means that we will prefer any indifference curve to the right over 1 to the left because more is better so for every 30 I'm getting more of oranges and that means I will prefer this combination sort of sort of X over Y on any day similar to the start is this this is the third one which is that indifference curves do not cross when we see indifference curve do not cross I'm going to show you first why indifference curve crossing may be problematic for us so let's say we have the diagram which is something like this let's say we have oranges and apples and let's make indifference curve to cross to see why they're crossing can be problematic so let's say this is I naught and there's another indifference curve which is for example i 1 okay and let's look at three combinations combination a combination B versus combination C now if I am on the same indifference curve then basically the logic is that I have the same utility from combination a and B so can I say this that a is rent equal to B why because they are on the same indifference curve I not right but E is always or it all is also equal to C because they are on the same interface curve i won now you can see this that if if because you were look at C was this B and I draw this sort of point then let's say if combination B was giving me twenty of apples and sort of 10 of oranges while combination C is giving me same 20 of apples but let's say 30 or rather twenty of twenty of oranges then clearly combination B is worse or combination C is preferred over combination B because for the same 20 I'm going more of oranges versus less of oranges so I have to say this where by looking at the diagram and say if more is better then C is greater than B but that doesn't make any logical sense because if you look at it if C is greater than B then C can't be equal to it because it is equal to B B and a is equal to C by that logic B should be equal to C and not C greater than B so in short indifference curves do not cross because if they do then it is logically inconsistent for them to cross the next one we want to talk about number four is to do with the idea that indifference curves are convex to the origin and rewrite this indifference curves are convex to the origin the reason why they are convex to the origin brings us to look at our first diagram so when you go back to our first diagram as you can see this the convex region means this kind of first shape where it is such that when I go from A to B for example I'm sacrificing six of oranges but I'm getting one of Apple but look at this when I go from from here to D point for example from D to e the sacrifice is minus 2 for for a plus 2 so if I find out the slope here my slope here is basically minus 6 which is change in Y over plus 1 which is change in Y over change in X so here my sacrifice is equal to minus 6 for every one Apple I am sacrificing 6 oranges but as you go to from D to e point or look at this the sacrifice here because if I look at the slope my sacrifice here would be 4 minus 2 which is change in Y or plus 2 which is going to be minus 1 so the slope is basically going down sacrifices going down as I buy more and more of apples and the reason is simply because of our utility theory which says this that as we buy more of more or as we consume more and more of a good the less we are willing to give up something else so as I get more and more of apples previously when I had very little lapis I was willing to sacrifice sacrifice six oranges for one Apple but now but I have sort of more apples I have like 13 or apples now for everyone sort of Apple I'm only willing to sacrifice one orange and that is exactly why convex through the origin shape suggests to us because if it isn't convex to the origin it will not follow our diminishing marginal utility so why is the curve convex to the origin and the answer is because of the law of law of diminishing [Music] diminishing marginal utility which means that as quantity Rises sort of MU Falls and that's why we are we are sacrificing less and that is exactly why our slope is reducing which explains why our indifference curve is actually convex and not concave or even linear our next discussion is about the slope of the indifference curve because sloped as an important concept of the what we call marginal rate of substitution so when I look at this diagram that we just discussed we can look at something called the marginal marginal rate of substitution so what is margarita we see that marginal rate of substitution simply the rate at which a consumer is willing to substitute one good for another and you can see this that when I go from A to B I'm the rate at which I'm sacrificing my sort of oranges for apples is for every one orange I'm sacrificing six of for every one Apple I'm sacrificing six of oranges at that same rate of substitution goes to four everyone sort of Apple I'm only sacrificing one of orange so moderate of substitution is simply our slope and it tells us what's the rate at which we are sacrificing or willing to substitute one good for data and we also say this this marginal rate of substitution is simply mu x over mu of y in other words in this case is good excess apples put wires oranges my slope or marginal rate of substitution is simply mu of apples or mu of oranges which is mu of codon x axis or mu of good on the y axis we are now in a position to discuss what we call our optimum consumption point let me write this optimum optimum consumption point this optimum consumption point is the same as us as a consumer maximizing maximizing our total utility from a given budget if I'm a consumer my goal is to maximize my totally from a given budget and that we say we can do that through our indifference curve so that's one element that I'm gonna bring here indifference curve and and our budget line so budget line tells us all the waste combinations that we could afford but indifference curve tells us all the combinations that I am sort of indifferent about and as a consumer I would like to consume along the highest possible indifference curve highest possible indifference curve means that the one indifference curve that is to the right will give me my maximum satisfaction than the one on the left so as long as I could afford it I would want to be on the highest possible indifference curve which will help me achieve my goal of maximizing my total utility from a given budget so now I'm going to put both the elements budget line and in the physical on the same diagram so let's see that let's say I have the two choices that I had before which was basically oranges and apples and let's say this is my budget line I can afford all the ways combination on this line now if my different curve indifference curve is for example I not what says indifference curve I one versus indifference curve pie - I would love to be on indifference curve I - the one on the right is always preferred to the ones on the Left which is i1 and I not but the problem is this that i2 is right now unaffordable given my budget line is this green budget line so with this green base line I do is an affordable so this is not a combination that I can afford and that's why it's not a combination which is going to be considered right now but I could I could totally buy combination for example a or combinations for example B and combination C why am I saying that because all these combinations a B and C are on I budget line and therefore they are affordable so if a consumer has a choice of buying a B and C which one really ultimately buy what we notice that a consumer is indifferent between a and B so between a and B he said he would say this is equal to B because they are on the same indifferent indifference curve I nod but C is preferred or a and C is also preferred over B why because C is on a high end difference curve if more is better then clearly C will be preferred over a and B and as you can see C is also affordable so ultimately the combination that the consumer will end up choosing we say this is the combination where the budget line budget line is tangent to tangent to the indifference curve and the reason why he consumer will choose this combination is because the maximum possible sort of satisfaction is always on the indifference curve which is to the right and yet affordable so the combination C is such that this green budget line is tangent to the indifference curve I won and Beyond I won I have all the unaffordable indifference curve but I won is the indifference curve that gives me the maximum possible satisfaction that I can buy from my limited income now at Point C what is important to see is that at C the slope of indifference curve indifference curve is equal to the slope of the budget line now if the slope of the indifference curve is equal to the slope of the budget line I can sort of say this that that mu of X or mu of Phi which is a slope of the budget of the indifference curve is equal to px over py which is the slope of the budget line which we've seen in the past video stop if mu X or mu Y is equal to px or py this is actually our equally marginal principle which we proved in our first video on utility so mu X I can rewrite this over px is equal to MU Y or py so from the indifference curve what we found out is the combination that a consumer will ultimately buy is the one within the Fisker is tangent to the budget line but that is also the combination where the slope of the indifference curve is equal to the slope of the budget line and therefore mu of X so price of X is equal to MU of y ou price of Phi which means at this point C let me go back to the diagram at this point see the Aiguille marginal principle is also true which means that I am maximizing my total utility from my given budget now this point C is also what we call consumer equilibrium so there are a lot of questions that come in exams which will ask us about what is it men in economic theory beckons you Micro Librium and the answer to this one is that if you use indifference curve analysis that is the point where the equal marginal principle is true and that is the point where basically we are saying that we will choose the indifference curve that is to the right and that is also a foldable which means it is tangent to the budget line that we have so remember this if there's a question about what is meant in economic theory about consumer cyclical equilibrium that is exactly what we need to write that for us economic analysis says is that an indifference curve that is to the right of my budget line and it's tangent to my budget line is the one which I will choose which gives me the maximum possible satisfaction and it is affordable and it is the point where the equal marginal principle is true that is the slope of the budget line is equal to the slope of the indifference curve a last part of the discussion is about how we can use indifference curves to derive derive demand curves now we will make demand curve for two kinds of goods one is what we call normal good normal good and another one is what we call inferior goods and within inferior Goods we will look at infinite goods which are given and those which are non given and I will explain given an artisan in a later part of our discussion but we are now about to juice this theory to look at how demand curves can be derived let's start with our normal Goods we know that normal Goods have what we call downward sloping demand curve which means that when the price of a good goes down price goes down we notice that the contrary demand it goes up and this basically prices going down the quantity demanded going up suggests to us that our demand curve for normal Goods is downward sloping and that's why that's why when the price goes down we know this the quantity demanded is going up this price going down for the demand going up this is what we call our price effect and the price effect is made up of two effects which are called substitution effect plus what we say income effect substitution effect and income effect we say they happen simultaneously and that's why they make our total price effect so what a substitution effects substitution effect simply say is this that if the price of a good goes down it will become relatively cheaper then it's substitutes so I mean is relatively cheaper then substitutes and because it becomes ready to be cheaper than substitute we will buy more of this code so substitution of substitution effects simply says buy more because the good is becoming cheaper than the substitute on the other hand your income effect says this that if the price of a good goes down the real income or purchasing power it goes up and if the real income of purchasing power is going up then we should buy more of this code if it is normal in it so because normal Goods by definition means normal in nature so normal Goods by definition mean that when our income go up our demand should rise and that if that is true then in the income effect because the price is going down my purchasing power go up I am going to buy more of this code show substitution of X's when the price goes down I should buy more buy more buy more and even income of X's buy more I'm now going to show this same substitution effect and income effect through indifference curve so when we draw our indifference curves and budget lines I'm going to show how the price of a good going down results in us to buy more of this code whenever price of a good goes down we learn from our budget line sort of discussion that that the budget line will pivot out so this is our apples quantity of apples and this is of oranges and let's say price of apples is going down if the price of Apple's go down we notice that our indifference curve will now become people shift pivotally out so this is my new indifference curve and the price of Apple's has gone down but when the price of Apple's go down two things are happening and we're saying both the substitution effect and income effect are happening so first thing first is what we need to look at is that how can we find out the income effect and substitution effect so in this line when I look at this line if this is my ultimate ultimate line which shows me my price effect this ultimate line that shows me price effect has both the substitution effect and income effects somehow what I need to do is remove my income effect from this to find out my substitution effect in other words when I'm trying to find out my substitution effect I need to keep lemma like this keep income constant so now keeping in the constant means removing from this pink line I will I want to remove my income to only isolate my substitution effect so if I remove income and I say my income is removed my budget line will move parallel backward this pink budget line assume there is no change in real income and therefore you can see this that it is kind of like telling us what if I was previously at white line on the white line and now I'm on the pink line on the orange line so moving from the white to the orange line simply means apples are becoming relatively expensive than orange but then from from this orange line I add my change in real income data so your income effect I ultimately go to the pink line and this pink line basically has both the substitution effect and the income effect so my first goal will be to look at our substitution effect the way we look at a substitution effect is that we will make an indifference curve that will be tangent to the white and then on an orange line so let me draw the graph of of an indifference curve that is tangent to both these bodies budget lines so if I look at my indifference curve I knot and let's say I was previously consuming q1 okay and Sun then price of apples fall which made me buy more of apples just because they're becoming relatively expensive than orange so if they're becoming relatively expensive than oranges I am moving from combination a to combination B and this move from combination a to combination B is simply my substitution effect and the reason why I'm saying it's my substitution effect is because it's on the same indifference curve because which means that I'm indifferent between a and B but I'm only buying more of P because it is becoming cheaper than apples and the fact that it is on my new sort of budget line it means that this budget line orange budget line is the one that only shows substitution effects so if the price of a good goes down I'm buying more of apples because it is becoming relatively cheaper but we said this that other than the substitution effect which they said when the price goes down substitution effects is buy more my income effect also said you know what the good is normal in nature and because the good is normal in nature we should buy more of that core so when you look at income effect I'm now going to make my indifference curve which is or the new line something like this and I am going to now consume combination combination see where my ultimate quantity is q3 now this q2 q3 is what we call our income effect so your subscription effects is when the price goes down you buy more of that good because the code is becoming cheaper and even the income effect is saying that because of because price has gone down your real income has gone up you should buy more of that code how do we use this knowledge to make a demand curve so lower down let's see if I want to make the demand curve for apples this is how it will it look like well my y-axis i have price of apples just price of apples and on my x-axis i have quantity of apples and I'm drawing right below the upper diagram because I'm gonna use this knowledge that I have about quantities from the upper diagram so when the price was for example high I was buying q1 because this was the quantity I was buying some by q1 when the price is high let's call it P not but when the price went down to sort of let's say p1 I'm buying q3 where did I get this huge reform this q3 is the same country as as this one so if I join these two point together these two points if I join them together I get myself what we call the demand for apples and you can see this this demand curve is downward sloping and the reason why is the downward sloping is because both income effect and substitution effect is saying we should buy more of this discord so when you're low but you're looking at a demand curve for normal goods it is downward sloping and it is downward sloping cause both both income effect and substitution effects says we should buy more of the good when the price of ticket goes down for inferior Goods I'm gonna first look at what we call non Giffen Goods so what are inferior Goods but in vehicles at those where when my income go up I should buy less of them so when you look at the price effect which says this that when the price of it would close down there is substitution effect and it is income effect that happens substitution effects is this let me say price is going down substitution effects is that because price is going down it is becoming relatively expensive we should buy more of this code so there is no difference between substitution effect in in the normal good and in an inferior court but income effect will be different because income effects is that when the price of a good goes down you should buy less of this good as real income goes up when price Falls so what we say is this that substitution effect is saying buy more income effect is saying buy less and so they kind of contradicting each other now the problem with infinite consciousness that if you goods are really low in price the fact that they are so low that implies that even though the price goes down we will have an income effect an income effect will be really small and the reason is very simple because these girls are extremely cheap they will not make significant impact on your income and as a result what we also say this that although income effect says buy less but because the core is inferior our substitution effect will always be greater than income effect and such is the case substitution effect is saying buy more income effect is saying buy less and because substitution effect is outweighed I mean like this s e outweighs ie says he says buy more ie says buy less ultimately my price effect will say buy more because our substitution effect is more powerful than income effect and I want to show this concept through our indifference curve so let's draw the indifference curve for infinite krishna so the same sort of process will be done for our infinite good so now let's say our apples are not normal but inferior Goods and we are going to make the price of apples fall so we will basically see the budget line to pivot out so my initial budget line is I say the white one like this one unless it then the price of Apple's are going down so my budget line becomes this pink one and I'm also going to now remove my real income to differentiate between substitution and income effect so I'm going to make a line which is parallel to my ultimate budget line saying that this was my initial budget line then the price effect will take us through this paint budget line but I'm gonna remove my change in rate income to look at substitution effect first and then income effect later the second thing we will do is that will make an an indifference curve that is tangent to the original line and the one where there is no income effect so my initial sort of indifference curve will be like this now I'm consuming for example a point that is tangent to my indifference curve because that's a rule where I'm maximizing my utility so I'm at point a and the quantity is less a q1 when the price went down substitution effect said buy more so I'm buying more so I go from A to B but because the good as inferior let me just write this substitution effect but because the good is inferior the problem that happens is that when I look at my in my budget line or the pink budget line I will now make an indifference curve that is tangent to the budget line but it is in between a and B it is at this point see where my income effect is telling me that I should buy less of this good as I go from q2 q3 and the reason is simple that because the good is inferior in nature diffusion effect is saying buy more and Ingram effect is saying buy less but income effect although it's moving in the opposite direction it's not powerful enough to outweigh substitution effect as a good is extremely cheap and therefore I can say this the substitution effect is greater than income effect and that's why we're buying more of this good I will show the same thing through our demand curve which will help us understand so I'm gonna make the demand curve for apples and the demand curve for apples will have price of apples here and on my x-axis I'm gonna have quantity of apples which is coming from the top diagram and I'm buying q1 before and I'm buying q3 later look at this guy's this quarterly change is past Mahler than the two quality change above because there was increment substitution effect I was both adding to my price effect but in this case my only substitution effect is saying buy more and indium effect is reducing that effect because income effect says I'm gonna buy less of this good so when I draw my diagram it will be look like lesser prices previously was like peanut I was buying a rather p1 I was buying this quantity a and then when the price went down to sort of be p2 I'm buying B so my demand curve will look like a downward slope in the mark-up of game but kind of a inelastic so it's still a downward sloping demand curve if somebody asks you about elasticity we can say it is that the normal Goods might have elastic demand because income a substitution effect they work in the same direction and they sort of reinforce each other while for the for the inferior good substitution effect miss a buy more but income effect is very little move into a negative direction and it says buy less but both the normal good and in vehicles have what we call a downward sloping demand curve which we need to understand our last discussion is about what we call Giffen goods what are given good well given goods are kind of inferior goods and we like this they are kind of inferior goods which means that they have what we call negative sort of income effect but the thing about them which is differentiating them from the other kind of inferior courts or non given inferior Goods is that they are very very low in price but despite being very low in price they actually also take up a large large proportion of a consumers expenditure consumers expenditure so these goals are extremely low implies a they are basically kind of inferior goods b-but they take up a large proportion of consumers income a good example of this could be your like demand for rice or local to rice in in somebody's sort of budget now when the price of these Goods sort of go down the substitution effects or say we should buy more of these Goods because the price is going down you're good rice is becoming relatively cheaper as compared to let's say bread we should buy more of that good but because these goods are sort of in feed Indonesia your income of excess is that when the price goes down you should buy less of these scores because they are inferior in nature so let me write this are for a Giffen goods for our Giffen goods the substitution effect says price goes down prices going down we should buy more of this code because it is becoming relatively cheaper than the substitutes but income effects is that prices going down because my real income is going up I should buy less of this code now the tricky part here or the part that we need to understand here is just that because these Goods take a large proportion of consumers income let's say if I'm somebody who's really poor and then he tries this rice is basically takes up a large portion of my income because it is a necessity for me my real income actually my income effect would be much larger so what we say is is that once in the Giffen goods become cheaper people actually have a large income effect so substitution effects is sort of buy more income of X's buy less and because the income effect is going to be large we say that income effect end up being created and substitution effect or income effect end up outweighing substitution effect and if income effect end up outweighing substitution effect what we have is a very unique case where the prices going down the quantity is also going down and we have what we call for the first time an upward sloping demand curve why because the income effect is saying we should buy we should buy less of this good in fact significantly less of this course oh poor guy poor person when the rice becomes really cheap he may end up cutting down the contrary of the rice he consumes maybe move to a better brand may be consumed more of bread maybe eat more of meat because now his price of rice is going down of the lower quality so how do I show that in terms of our indifference curve let's rather diagram quickly so following the same steps you can see this that if the price was previously the budget line was previously the white line when the price of Apple's go down we move to this budget line the pink budget line and then we say it is that are we need to remove our income effects so we will draw our budget line which is going to be parallel to our sort of the ultimate sort of budget line of the new budget line now the white line is where I am originally going to be the the orange line is where I will be after my substitution effect and the pink line is where I will be after my price effect so the way I want to make my indifference curve is that I'm going to be like at point sort of here so my initial point is point a and I'm buying q1 when the price goes down substitution of X is PI more because the goodies becoming cheaper submissively always say buy more because of them because of what is becoming cheaper now income effect says wait a minute this is a new video good in fact it's a Giffen good which is inferior good but extremely low price income effect would say buy less of this good in fact significantly less of this card so we will ultimately move from indifference curve I not I'm going to move to indifference curve I want but see what is happening here my new indifference curve is drawn in such a manner that I have ultimately ended up being at q3 which is even below my first point the income effect is much more powerful so much so than it has completely outweighed my my substitution effect so if I draw the demand curve right below when the price is for example high let's say p1 I am buying q1 so this is my demand for apples but when the price sort of goes down to p2 I'm buying this q3 quantity so if I join the two points together I get myself what we call a demand curve which is upward sloping so this is my let me zoom this picture this is my let me also label it properly this is my price of apples this is my quantity of apples and I have what we call an upward sloping upward sloping demand curve where I ended up from point A to point D so if I give you the quick summary for normal Goods the demand curve is downward-sloping for inferior goods to the mark of his down low sloping but for Giffen Goods the demand curve is upward sloping so if Ingrid is the only sort of demand curve where is the only good way the demand curve would be up for swapping the second thing is this that for normal goods substitution effect an income effect it reinforces each other but for for inferior goods the substitution effect and income effect they move in the different direction but because income effect is small substitution effect kind of outweighs income effect and that's why the demand curve is downward sloping but in the case of given good the substitution effect is less powerful than the income effect income effect and stuff outweighing substitution effect and that's why we will have an upward sloping demand for for given coach