PPA 723: Managerial Economics: Indifference Curves

The Maxwell School, Syracuse University
Professor John Yinger
PPA 723: Managerial

Economics
Lecture 5:
Indifference Curves
Managerial Economics, Lecture 5: Indifference Curves
Outline
 Properties of Consumer Preferences
 Indifference Curves
Tastes
 Individual tastes (preferences) determine
the pleasure people derive from different
goods and services
 Our objective is to determine how a

consumer’s tastes influence its decisions
(positive analysis), not to judge tastes
(normative).
Standard Assumptions About

Consumer Preferences
1. Completeness
2. Transitivity
3. More is better
Assumption 1: Completeness
 Consumer can rank any two bundles of
goods
 Only one of the following is true: The

consumer
prefers Bundle x to Bundle y
prefers Bundle y to Bundle x
is indifferent between the two bundles
Assumption 2: Transitivity (Rationality)

 A consumer's preference over bundles
is consistent:
If a consumer prefers Bundle z to Bundle y

and Bundle y to Bundle x
Then that consumer prefers Bundle z to

Bundle x
Assumption 3: More is Better

More of a good is better than less of it.
Good: commodity for which more is
preferred to less at least at some
levels of consumption
Bad: something for which less is
preferred to more, such as pollution
Consumers are not satiated.

Figure 4.1a Bundles of Pizzas and Burritos Lisa Might Consume
(a) Ranking Regions B, Burritos

per semester
c A
25
20 f
15
e a
d
10 b
0 15 25 30
Z, Pizzas per semester
Figure 4.1b Bundles of Pizzas and Burritos Lisa Might Consume

(b) Indifference Curve B, Burritos
per semester
c
25
20 f
e
15
a
d I
10 b
0 15 25 30
Figure 4.1c Bundles of Pizzas and Burritos Lisa Might Consume

(c) Preference Map B, Burritos
per semester
c
25
20 f
I2
15 e
d
10 I1
I0
0 15 25 30
Indifference Curve Properties

1. Bundles on indifference curves farther
from the origin are preferred to those on
indifference curves closer to the origin.
2. There is an indifference curve through
every possible bundle.
3. Indifference curves cannot cross.
4. Indifference curves are “thin”.
5. Indifference curves slope down.
Two Indifferent Managerial Economics, Lecture 5: Indifference
Curves
Figure 4.2a Impossible Indifference Curves

(a) Crossing B, Burritos
per semester
e
b
a I1
I0

Figure 4.2b Impossible Indifference Curves

(b) Upward Sloping B, Burritos
per semester
Z , Pizzas per semester

Willingness to Substitute
 Downward-sloping indifference curve ⇒
consumer is willing to substitute one
good for the other.
 Marginal rate of substitution (MRS) of
burritos (rise) for pizza (run), is slope of
indifference curve:
∆B
MRS =
∆Z
Marginal Rate of Substitution

B, Burritos
per semester
∆ B MRS = ∆ B/∆ Z
∆ Z
I

MRS Varies Along an Indifference

Curve
 Indifference curves bow away from the

origin (called convex).
 Indicates diminishing marginal rate of

substitution (MRS).
Figure 4.3a Marginal Rate of Substitution

(a) Indifference Curve B , Burritos
Convex to the Origin per semester
a
8
–3
b
5
1
–2
c
3 1
–1 d
2
1
I
0 3 4 5 6
Unlikely Outcome:
Concave Indifference Curve
 If indifference curve bows toward the origin

(concave),
 Then (implausibly) the consumer has an

increasing MRS.
Figure 4.3b Marginal Rate of Substitution

B, Burritos (b) Implausible Indifference Curve
per semester that is Concave to the Origin
a
7
–2
b
5
1
–3
c
2
1
I
0 3 4 5 6
Figure 4.4a Perfect Substitutes

Coke, Cans
per week
4
1
I1 I2 I3 I4
0 1 2 3 4
Pepsi, Cans per week
Figure 4.4b Perfect Complements

Ice cream,
Scoops per week
e c
3 I3
d b
2 I2
a
1 I1
0 1 2 3
Pie, Slices per week
Figure 4.4c Imperfect Substitutes

B, Burritos
per semester

Utility
 Utility is a number that reflects the relative
rankings of various bundles of goods
 If Lisa prefers bundle A to B, then utility from

A must be greater than utility from B
 A utility function is a:
 relationship between a utility measure and every
possible bundle of good
 succinct summary of information in an indifference
curve map
Utility and Marginal Utility

 The marginal utility of Z is:
∆U
MU Z =
∆Z
 MUZ is the change in utility from a small

increase in Z holding B fixed
U , Utils
Utility
350 U (10,Z )
Utility function,
250
230 ∆ U = 20
∆ Z =1
0 1 2 3 4 5 6 7 8 9 10
MU Z, Marginal Marginal Utility

utility of pizza
130
20
MUZ
0 1 2 3 4 5 6 7 8 9 10
Totals, Margins, and Averages

 Economic analysis often depends on the
distinction between a total, a average, and a
margin.
 In the case of utility

 U = total utility
 U/Z = average utility of Z
 MUZ = marginal utility of Z
Utility and the Marginal Rate of

Substitution
 Let A = the good on the vertical axis
and B = the good on the horizontal axis,
 Then (note the inversion):
∆A MU B
MRS = =−
∆B MU A
Marginal Rate of Substitution
Quantity of A
Give up
∆ A MRS = ∆ A/∆ B = - MUB/MUA
one unit
of A
Gain MUA units of utility, ∆ B

which can “buy” I
MUA / MUB Units of B
Quantity of B
Deriving the Marginal Rate of

Substitution
∆U = 0 = ∆A( MU A ) + ∆B ( MU B )
= MU A + ∆B( MU B )
MU A
∆B = −
MU B
∆A −1 MU B
MRS = = =−
∆B MU A / MU B MU A

PPA 723: Managerial Economics: Indifference Curves

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The Maxwell School, Syracuse University

Professor John Yinger

PPA 723: Managerial

 Properties of Consumer Preferences

 Our objective is to determine how a

Standard Assumptions About

 Only one of the following is true: The

Assumption 2: Transitivity (Rationality)

If a consumer prefers Bundle z to Bundle y

Then that consumer prefers Bundle z to

Assumption 3: More is Better

Consumers are not satiated.

Figure 4.1a Bundles of Pizzas and Burritos Lisa Might Consume

(a) Ranking Regions B, Burritos

Figure 4.1b Bundles of Pizzas and Burritos Lisa Might Consume

Figure 4.1c Bundles of Pizzas and Burritos Lisa Might Consume

Indifference Curve Properties

Figure 4.2a Impossible Indifference Curves

Z, Pizzas per semester

Figure 4.2b Impossible Indifference Curves

Z , Pizzas per semester

Marginal Rate of Substitution

Z, Pizzas per semester

MRS Varies Along an Indifference

 Indifference curves bow away from the

 Indicates diminishing marginal rate of

Figure 4.3a Marginal Rate of Substitution

 If indifference curve bows toward the origin

 Then (implausibly) the consumer has an

Figure 4.3b Marginal Rate of Substitution

Figure 4.4a Perfect Substitutes

Figure 4.4b Perfect Complements

Figure 4.4c Imperfect Substitutes

Z, Pizzas per semester

 If Lisa prefers bundle A to B, then utility from

Utility and Marginal Utility

 MUZ is the change in utility from a small

MU Z, Marginal Marginal Utility

Totals, Margins, and Averages

 In the case of utility

Utility and the Marginal Rate of

Gain MUA units of utility, ∆ B

Deriving the Marginal Rate of

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