Preferences & indifference curves

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:

1. Preferred
2. Indifferent
3. 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.

Note:

1. 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.
2. 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