In this section, we will see how we can create a map that shows a person’s preference.
Preference Maps & Indifference Curves
Assume there is good x and good y. Then a person’s preference on the combination of these two goods are sorted into three categories:
- Not Preferred
The curve that separates the preferred region from the not preferred region is the indifference curve.
Indifference Curve: a curve that shows a combination of goods in which the consumer sees as equal value.
Note: We can have a family of indifference curves.
Marginal Rate of Substitution
Marginal Rate of Substitution (MRS): the rate which a consumer will give up good y to get an additional unit of good x while remaining indifferent.
The MRS can be found by calculating the tangent slope of the indifference curve at a specific preference.
- If the indifference curve (or slope) is steep, then the
MRS is high. This means the consumer is willing to give up a lot of good y for an additional unit of good x.
- If the indifference curve (or slope) is flat, then the
MRS is low. This means the consumer is willing to give up very little good y for an additional unit of good x.
Diminishing Marginal Rate of Substitution: the MRS decreases (tangent slope on the indifference curve becomes flatter) as we increase the quantity of good x.
The less good y a consumer has, the less a consumer is willing to give up good y for good x while remaining indifferent.
Degree of Substitutability
The shape of the indifference curves tells us the degree of substitutability between two goods.
Ordinary goods: the indifference curve is convex.
Perfect Substitutes: The indifference curves are lines, with a
MRS of 1.
Perfect Complements: The indifference curves are L-shaped