Overview
This lecture explains how consumer preferences between two goods can be represented and analyzed using indifference curves and the concept of the marginal rate of substitution.
Preferences and Utility
- Preferences are an individual's tastes for different goods and are crucial in consumer choices.
- Utility is the satisfaction derived from consuming goods; more goods generally mean higher utility.
Indifference Curves
- An indifference curve connects combinations of two goods that provide the same level of utility (satisfaction).
- Being "indifferent" means you have no preference between two combinations of goods.
- Higher indifference curves (further from the origin) represent higher utility levels.
- Indifference curves are usually bowed inward due to changing marginal rates of substitution.
Marginal Rate of Substitution (MRS)
- The MRS is the rate at which a consumer is willing to give up one good to obtain more of another while keeping utility constant.
- The MRS is found by the slope of the tangent to the indifference curve at any point.
- As you have more of one good and less of the other, the MRS decreases (diminishing marginal utility).
Special Cases of Indifference Curves
- Perfect substitutes: Indifference curves are straight lines; MRS is constant.
- Perfect complements: Indifference curves are right angles; goods are consumed in fixed proportions.
Properties of Indifference Curves
- Indifference curves slope downward; to maintain the same utility, more of one means less of the other.
- Indifference curves cannot cross, as that would imply contradictory utility rankings.
- For goods, more is preferred (further from origin); for bads (like pollution), less is preferred (closer to origin).
Preferences vs. Constraints
- Preferences show what consumers would like, but actual choices depend on income and market prices.
Key Terms & Definitions
- Utility — Satisfaction gained from consuming goods or services.
- Indifference Curve — A curve showing combinations of goods that provide equal utility.
- Marginal Rate of Substitution (MRS) — The amount of one good a consumer will give up to get more of another, keeping utility unchanged.
- Perfect Substitutes — Goods that can replace each other at a constant rate.
- Perfect Complements — Goods that are always consumed together in fixed proportions.
Action Items / Next Steps
- Answer the provided practice questions to reinforce your understanding.
- Prepare for the next lesson on choices constrained by income and prices.