COR2100 Demand Preferences PDF

25/07/2024 COR2100 Demand Preferences indifference curves budget constraint...

25/07/2024 COR2100 Demand Preferences indifference curves budget constraint Dr Lam San Ling 2024-2025 Term 1 1 Page 2 Indifference curve - definitions  Indifference curve - An indifference curve with respect to two goods is a graph showing combinations of the two goods that leave the consumer equally well off or equally satisfied (“indifferent”) in having any combination on the curve [adapted from Investopedia] - Set of bundles that provide an equal level of satisfaction for the consumer [AL&L] o Utility: (abstract) measure of the level of satisfaction 2 1  25/07/2024 Page 3 Indifference curve - example (adapted from AL&L) Y (sweaters) All combinations of X, Y on this curve yield the same utility to the consumer  Slope = marginal rate of substitution between goods X and Y Drawn convex to the origin X (jeans) 0 3 Page 4 Indifference curve - example (adapted from AL&L) Y (sweaters) All combinations of X, Y on this curve yield the same utility to the consumer  U1 = U (x1, y1) = U(x2, y2) = …. y1 y2 y3 U1 X (jeans) 0 x1 x2 x3 4 2  25/07/2024 Page 5 Indifference curve - example (adapted from AL&L) Y (sweaters) Increasing utility  Indifference curves do not intersect  U1 < U2 < U3 U3 U2 U1 X (jeans) 0 5 Page 6 Budget constraint - example (adapted from AL&L) Y (sweaters) NOT affordable If income = M; prices are P(x), P(y); and quantities consumed are Q(x), Q(y), then Budget constraint represented by:  P(x).Q(x) + P(y).Q(y) ≤ M (green line) P(x).Q(x) + P(y).Q(y) = M Affordable: within budget constraint X (jeans) 0 6 3  25/07/2024 Page 7 Budget constraint - example (adapted from AL&L) Y (sweaters) Increasing income If income = M; prices are P(x), P(y); and quantities consumed are Q(x), Q(y), then Budget constraint represented by:  P(x).Q(x) + P(y).Q(y) ≤ M (green line) M3 M1 M2 X (jeans) 0 7 Slide 8 how does consumer Maximise utility subject to budget constraint? 8 4  25/07/2024 Page 9 Maximise U s.t. budget constraint Y (sweaters) Optimal consumption (x, y):  where budget line is tangential to the highest indifference curve y Cannot afford due to budget constraint budget line Can afford but not at max budget X (jeans) 0 x 9 Slide 10 differently-shaped Indifference curves 10 5  25/07/2024 Page 11 Indifference curve - what if: X and Y are perfect substitutes? Y (Dettol soap) A: Perfect substitutes: IC is a straight line X (Dove soap) 0 11 Page 12 Indifference curve - what if: X and Y are perfect substitutes? Y (Dettol soap, Pepsi) Buys only Y A: Perfect substitutes: IC is a straight line Consumer will buy either Y or X (not both), depending on relative price Budget constraint X (Dove soap, Coke) 0 12 6  25/07/2024 Page 13 Indifference curve - what if: X and Y are perfect substitutes? Y (Dettol soap, Pepsi) A: Perfect substitutes: IC is a straight line Consumer will buy either Y or X (not both), depending on relative price Budget constraint Buys only X X (Dove soap, Coke) 0 13 Page 14 Indifference curve - what if: X and Y are perfect complements? Y (Left shoe) A: L-shaped IC (“Leontief” utility function) X (Right shoe) 0 14 7  25/07/2024 Page 15 Indifference curve - what if: X and Y are perfect complements? Y (Left shoe, Car in Singapore) A: L-shaped IC (“Leontief” utility function) Consumer will buy X, Y in a fixed ratio Budget constraint X (Right shoe, COE) 0 15 Page 16 the end Thank you  16 8  25/07/2024 Slide 17 References  AL&L (2021), Economics - Chap 5 o Appendix (representing preferences with indifference curves) 17 9