An indifference curve is a line showing all the combinations of two goods which give a consumer equal utility. In other words, the consumer would be indifferent to these different combinations. Show Example of choice of goods which give consumers the same utility
Table plotted as indifference curveDiminishing marginal utilityThe indifference curve is convex because of diminishing marginal utility. When you have a certain number of bananas – that is all you want to eat in a week. Extra bananas give very little utility, so you would give up a lot of bananas to get something else. Indifference curve map
We can also show different indifference curves. All choices on I2 give the same utility. But, it will be a higher net utility than indifference curve I1. I4 gives the highest net utility. Basically, I4 would require higher income than I1. Budget lineA budget line shows the combination of goods that can be afforded with your current income.
If an apple costs £1 and a banana £2, the above budget line shows all the combinations of the goods which can be bought with £40. For example:
Optimal choice of goods for consumer
Income-consumption curve
As income rises, you can afford to consume on higher indifference curves. This optimal choice will shift to the right. This we can plot consumption as income rises. Impact of lower priceWith a lower price of bananas (from £2 to £1.50), we can now afford more bananas with the same income. The budget line shifts to the right
With lower prices, we can now consume at a higher indifference curve of IC2, enabling more bananas and apples. Income and substitution effect of a rise in priceWhen the price of a good rises. People buy less for two reasons
Income and substitution for a normal good
To find different substitution and income effects.
Income effect
Effect of a rise in the price of an inferior good
Giffen goodsA Giffen good occurs when the income effect outweighs the substitution effect. This is quite rare, but it is theoretically possible for poor peasants who have a choice between expensive meat and cheap rice.
We start at Q2, the rise in the price of rice, reduces the budget line for rice to B2. But, the fall in income causes a large income effect that outweighs the substitution effect. Demand for rice rises to Q3 with a big fall in demand for meat. Related
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