Econ 101 Indifference Curves:

Indifference curves are graphs which incorporate the idea of tastes or preferences.


We assume that consumers are rational thinkers, and that they can rank their preferences. There are three parts to this 'rationality':

1- COMPLETE the consumer must either prefer good A to good B, good B to good A, or be indifferent
2- REFLEXIVE A is always as good as A. Preferences don't change based on exogenous variables
3- TRANSITIVE If A > B and B > C, then A > C

THESE SUBJECTIVE PREFERENCES ARE INDEPENDANT (EXOGENOUS).
-We cannot make comparisons between different people (because you can't compare my happiness to yours)
-We cannot make comparisons between different times
-This shows us that psychology is the basis of microeconomics!

HOKAY! Now that the background stuff is out of the way, let's actually look at one of these again.

FUNCTION OF A UTILITY CURVE: U = U(x,y) higher number = higher utility...

All of the different points on one indifference curve show different combined quantities of 2 goods (x and y) which yield a constant total utility.
Because the utility derived from any product is different for different people, the indifference curve shows PERSONAL PREFERENCES.

CHARACTERISTICS:
For any two products, there are an infinite number of indifference curves expanding outward. The total utility for each progressive curve is higher than the last one, because each progressive curve represents a greater combined quantity of goods x and y, and in most cases, we prefer to have MORE (more goods = greater total utility).

Two indifference curves for the same product cannot cross, because that would suggest that we can achieve the same total utility with a set combination of x and y as we could with the same quantity of x, but fewer of y. Also the point of intersection would imply two different total utilities for the same combination of goods. That's illogical.

EQUATION: Change in X (Marginal utility of X) + Change in Y (Marginal utility of Y) = 0

Why? Because if two points are on the same indifference curve, the utility lost on one axis is gained on the other axis.

utility lost = Change in X (Marginal utility of X)
utility gained = Change in Y (Marginal utility of Y)

The slope of the indifference curve = change in X/change in Y

OR

negative marginal utility of X/marginal utility of Y

OR

the marginal rate of substitution!

COMBINING BUDGET LINES AND INDIFFERENCE CURVES:
both budget lines and indifference curves have the same axes: quantities of different products. Budget lines show us possible combinations of different products, and indifference curve show us desired combinations of different products!

REMEMBER, price changes are represented as rotations or stretches of the budget line. SO, if the price of soda falls, the budget line for soda stretches out further along the x-axis, and the possible quantity of soda increases. Consumers want to maximize total utility, so places where the indifference line meets the budget line represent the demanded combinations of goods, given the prices of both products. As the prices of a good falls, consumers substitute into that good in order to reach higher indifference curves with the stretched budget line.
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In this way, we can see the formation of a demand curve- consumers buy greater quantities of a product as the price decreases in order to maximize total utility (intersect with the highest indifference curve). This results in a negatively sloped demand curve.

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Econ 101: More on deriving supply curves!

UBC is pretty awesome according to the Globe and Mail.

OKAY:

Conspicuous Consumption Goods
Veblen coined this term in 1900 with "The Theory of the Leisure Class"
Basically, he asserted that certain goods have "snob appeal" and can be seen as "status symbols"
Things like designer clothes and big expensive cars.
Here, the substitution effect is POSITIVE! So, as relative prices of conspicuous consumption goods rise, consumers buy more of them. What this shows is that:
-Happiness is relative (we often derive our happiness by comparing what we have with what other people have. As such, exclusive products (made exclusive through high prices) often make us very very very happy.
-There is a great deal of passive consumption which occurs. Advertisements brainwash us into buying certain products, and we never really question whether we really like them, or if we are just buying them because we feel we have to.

Conspicuous Consumption Goods:
-The demand would probably be negatively sloped if consumers could buy the good without anyone knowing the prices (in other words, the public knowledge of the exclusivity of the product is what causes this positive substitution effect). It isn't as simple as we'd like to think- sometimes dropping the price will sell more.
-These goods may exist for the individual, but not for the entire market

BEWARE: A positive substitution effect may look like an overly positive income effect... but these two situations are very different.

Giffen Good: Negative substitution effect over shadowed by price effect
Conspicuous Consumption Good: The Substitution Effect is positive.

CONSUMER SURPLUS:

We can arrange the maximized total utility formula like so:
The marginal utility of product X = (The Price of Product X / The Price of Y) X The Marginal Utility of Y

Let Y be money.
Let the price of 1$ be 1
Let the marginal utility of money remain constant.

Then..
The marginal utility of a product is the price of that product times the marginal utility of money! Thus, demand is a marginal utility curve.

So...

The marginal utility gained from an extra unit of product X is the utility of the money spent to purchase that good.
WE KNOW that marginal utility diminishes as consumption increases
WE KNOW that the marginal utility of a product is the price of that product times the marginal utility of money.... so

Consumer surplus is the difference between what the consumer is willing to pay, and what the consumer must pay for a product.
The demand curve price is the price the consumer is willing to pay for each additional unit of a good (notice, it goes down as more and more of the good is consumed)
The market price is the price consumers actually pay to receive this good.


The total utility lost is the boxed area.
The total utility gained is the entire pencil-shaped area
The consumer surplus is the difference between what the consumer is willing to pay and what the consumer must pay. It's FREE HAPPINESS!


The producer surplus is the difference between the cost of producing each unit and the market price.

THE PARADOX OF VALUE:
People value water very highly, and yet they pay a very low price for it. Why? Because the MARGINAL UTILITY of water is very low compared to other products (1 glass of water is not worth as much to us as one glass of coke). The important point is not to mistake total utility for marginal utility.

HOKAY
Now onto the next part of this unit:
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Indifference Curve Analysis:

Decision Theory or Choice Theory:
-There are three factors at work when we choose how to allocate our incomes: How large are incomes are, the prices of the products we want to purchase, and our personal tastes.

A BUDGET LINE shows all possible combinations of two goods given your income (Y) and the price of the two goods (sort of like a PPC, but for consumers).

A budget line incorporates two of the three factors: income and prices.
So let's say tacos cost $1 and burgers cost $3. I have a $30 income, so this is my budget line:

The maximum quantity of tacos I can buy is 30
The maximum quantity of burgers I can buy is 10

We can play with the prices and incomes to change the shape of the budget line.

THE EQUATION OF A BUDGET LINE:
(Price of Product A X Quantity of Product A) + (Price of Product B X Quantity of Product B) = Income

The slope = -(price of product on X axis/price of product on Y axis)
or... -(maximum quantity of product on Y axis/maximum quantity of product on X axis)
or -(income/price of the product on the Y axis)/(income/price of the product on the x axis)

The slope is the ratio of the relative prices
The slope is also the opportunity cost.

If income changes, the budget line moves parallel to it's previous position. It's a positive relation. If income increases, it shifts out and vice versa.

If relative price change, then the budget line will rotate and the slope will change. As price increases on one axis, the quantity decreases for that product, so there is a negative relation.

A proportional change in both price is like an income change (ie a price effect)
If both prices and your income change proportionally, the budget line will not change.

THATS ALL!