Indifference Curve

We saw Jose is giving up certain number of one good to get more number
of the other good.

Suppose you ask Jose- why did you opt for 4 movies and only 2 t-shirts?
You could have bought one more t-shirts if you had watched 3 instead of
4 movies.

What do you think his response might have been?

He might say I don’t care- I wanted to see 4 movies and I don’t care if I
have to settle for only 2 t-shirts.

His response reflects his indifference to what he didn’t get because of

his choice to get his preferred combination of two goods.

This can be shown through an indifference curve- it shows the consumer

is indifferent between the combinations on the curve.

In other words, the consumer does not prefer one combination over the
other because both give same level of overall satisfaction.
 Indifference Curve
Movement along the indifference curve shows how the consumer is substituting
one good for another while keeping same level of satisfaction.

But what does that mean?

The tangency point on the curve is a point where two factors are meeting-
- What the consumer is willing to give up
- What the market forces push the consumer to give up

Based on remembered or perceived utility of the good, the consumer decides

what combination will give them more satisfaction. This decision is based on
personal trade off and reflects the consumer’s preferences.

Now the market trade off- the budget line shows how much of one good (on Y) a
consumer must give up to buy one more unit of another good (X). This trade off
reflects market and is determined by prices.

Thus, at the tangency point:

consumer’s trade off (personal preferences based) = market trade off (price base
Indifference Curve

The blue part of this diagram shows more preferred

combination as they consist of more of one item without
reducing the number of another item.
But given the budget constraint, the consumer cannot afford
those options. The blue area is beyond the budget line.

The orange part or the region close to the origin point shows
less preferred combinations as it includes less number of
both items.

So the consumer would stay on the budget line and opt for
the tangency point option where their tradeoff is equal to the
market trade off or the combination that will give them
maximum satisfaction while staying within their budget
limits.

Budget line is about affordability while indifference curve is about

preferences.
Why the indifference curve is a curve and bowed inward?
An indifference curve shows the combinations of options that gives consumer same level of satisfaction and its
bowed inward.

Lets first understand the key properties of Indifference Curve- it has four key properties-

1. Higher indifference curves are preferred as it presents greater quantities of goods

2. Indifference curves slope downward as it shows the rate at which a consumer is willing to substitute a
good for another good. So if quantity of one good increases, the quantity of another good decreases
(given the budget constraint)

3. Indifference curves do not cross as crossing would imply that the number of goods consumed does not
impact a consumer’s satisfaction level- or the consumer is equally satisfied with fewer and larger
quantities of goods

4. Indifference curves are bowed inward as it reflects the consumer has a greater willingness to give up
anything they have in abundance. This curve shows the consumer’s marginal rate of substitution.

But why it’s a curve?

It’s a curve as the rate at which the consumer is willing to trade off one good for another good is not constant
Perfect Substitutes and Perfect Complements
• So far we saw a regular or common indifference curve that shows a consumer’s willingness to trade off one
good for another good.

• Relatively less bowed curve shows a consumer’s ease to substitute one good from another. It shows the curve
does not change much as we move along the curve.

• This curve is very bowed when the consumer finds two goods hard to substitute. This curve moves sharply
inward as we move along the curve and reflects consumer’s unwillingness to substitute one good for another
good.

• When the marginal rate of substitution is constant, the indifference curves are straight lines. This is called
“perfect substitutes” (same quality product of two brands, or 5 notes of 100 Rs & 1 note of 500 Rs. Etc.)

• When two goods are perfect complements for each other, the indifference curves are right angle because
utility increases only when both goods increase together in required ratio. (eg. bundle of 5 left shoes & 5 right
shoes vis a vis 8 left shoes and 5 right shoes).

• The Y axis in this case shows increasing one good alone does not increase satisfaction- and same goes for the
X axis. The utility increases only at the corner which represents a fixed proportion.

Instances of perfect substitutes and perfect complements are very rare in real world and what we mostly see is a
bowed curve.
Impact of Rise in Income on Budget Line
We saw the blue area of this diagram is consumer’s preferred choice as this is an
option with more quantity of both goods. But its beyond their budget limit.

But what if their income increases?

Rise in income –
- Consumer can afford to buy more of both goods
- Shifts the budget line outward
- The new budget line is parallel to the original line
- The slope of the new line does not change as the prices are still constant
- However, the intercepts of both axes increases and shows increased
purchasing power of the consumer
- While the opportunity cost between the two goods remains the same, the
range of affordable options expands

What if there is decline in income?

 Impact of Fall in Price on Budget Line

Another important factor that influences consumer’s willingness

to buy is change in price.

In case the price drops-

- The consumer can afford more of those good/s with same
income
- In this case, the budget line will rotate outward from the
intercept of the other good
- The intercept of the good whose price falls increases, while the
intercept of the other good remains unchanged (as its price and
income remain constant)
- Budget line’s slope also changes because of the change in
relative price ratio

And what if price increases?

Marginal and Total Utility
Like well-being, utility cannot be measured quantitatively in the real world. But No. of Total Marginal
Economists have developed models to measure it and we are referring to those
models to understand utility. T-shirts Utility Utility
0 0 0
This table shows the total and marginal utility Jose is getting from buying t- 1 8 8
shirts in a month.
2 14 6
The firs t-shirt gives him 8 units of total utility. Since this is the first t-shirt, the 3 17 3
marginal utility will be equal to the total utility
4 16 -1

The marginal utility will start declining or diminishing with each additional unit
of the t-shirt that Jose buys

After buying the 3rd t-shirt, the marginal utility he gets from buying t-shirt
becomes negative and it is assumed that now Jose will stop buying t-shirts
As a rational consumer, Jose will
On the other hand, the total utility will keep increasing with each additional not buy more than 3 t-shirts and
quantity of t-shirts until Jose stops getting any satisfaction from buying t-shirts this will be reflected on his budget
line
If he continues buying any additional unit after this point, the total utility will
also start declining.
 Total Utility Curve
The relationship between utility and quantity of any product consumed
is called utility function or a total utility.

The marginal utility of any product decreases with consumption of

additional unit of that product because of the law of diminishing
marginal utility

The total utility the consumer derives from the consumption of

additional units increases with increase in quantity consumed.

Marginal utility curve is a downward slope as each extra unit gives less
additional utility.

Total utility begins near the origin and slopes upward.

It increases at a decreasing rate as the marginal utility keeps falling

with additional consumption. It moves upward but becomes flatter
over time.

Marginal utility becomes zero at the peak and after that total utility
starts declining or becomes negative.
Consumer Behavior
A study conducted in 2010 (to chose between 6 vis a vis 24 options) shows consumer usually prefer to
select from a limited choice options (Godwin, 2010).

With multiplying options, as like Barry Schwartz and Daniel McFadden notes consumer reaches to a point
where they find processing too many options troubling.

Consumers buy any commodity based on their prediction about the utility they will get from the
commodity. And this prediction is based on perceived and remembered utility.

This prediction is based on perceived or remembered utility and if these two and evidence suggest this
prediction is often incorrect.

Consumers’ welfare is measured based on demand curves, which assume that a consumer’s predicted
utility matches the remembered utility.

However, several research shows these two often do not match and in such cases welfare analysis based
on demand curve will not be correct. It will not represent the utility the consumer is actually deriving from
consuming that particular commodity.

Any idea why remembered and predicted utility does not match in many cases?
Consumer Behavior So what would a consumer chose?

There are many factors that determine consumer Consumer is getting a marginal rate of
behavior, such as- satisfaction or utility from consuming
- Budget constraint
any amount of a product.
- Utility or satisfaction (perceived and remembered)
- Consumer’s preference Another important factor is that the
consumer is comparing and assess the
- Opportunity cost marginal rate of substitution they are
- Income change deriving at a certain price.
- Substitution
- Rationality and Optimization The consumer choses the combination
- Other factors like social norms, habits,
of the two goods where the amount they
advertisement etc. are willing to trade matches the rate at
which the market allows them to trade.
Most advertisement, as Christopher Lasch has also
observed, reinforce a well established and clear This reflects the marginal rate of
correlation between happiness and consumption- satisfaction for the consumer equals the
wherein happiness depends on consumption. relative price.
Total & Marginal Utility- exercise
Suppose that Antonio’s total utility from different No. of Total Marginal
quantities of snacks per day is given by the table Snacks Utility Utility
below. per day
0 0
a. Draw and label Antonio’s utility function for 1 20
snacks. 2 40
b. Fill in the last column of the table above, 3 60
calculating Antonio’s marginal utility from
snacks. 4 75
c. Does Antonio always display diminishing 5 85
marginal utility in his satisfaction from 6 90
snacks?
7 85
d. Assuming Antonio is rational, what is the 8 75
maximum number of snacks that he could
choose to consume per day?
Total & Marginal Utility
No. of Total Marginal
Snacks Utility Utility
per day
0 0 0
a. Draw and label Antonio’s utility
function for snacks. 1 20 20
2 40 20
b. Fill in the last column of the table
above, calculating Antonio’s 3 60 20
marginal utility from snacks. 4 75 15
c. Does Antonio always display 5 85 10
diminishing marginal utility in his 6 90 5
satisfaction from snacks?
7 85 -5
d. Assuming Antonio is rational, what
is the maximum number of snacks 8 75 -10
that he could choose to consume
per day? b. Antonio’s marginal
a. Antonio’s utility function for utility from snacks.
snacks.
MU= TUn- TUn-1

MU of Snack 2= 40-20
= 20
Theory of consumer behavior This equation can be rearranged algebraically as a slope
intercept form.
Can we calculate consumer behavior? And what is an algebraical slope intercept form?
Lets assume the quantities of the two goods purchased or consumed Slope is a straight line which is expressed in algebra as:
are X and Y. y=a +bx
Lets assume number of movie tickets Joe is buying are X and number Here a is the point where the line touches the y axis; b is
of t-shirts he is buying are Y. the slope of the line; x is the independent variable and y
is the dependent variable
These two goods are available to Joe and can be expressed on a
budget line. Since budget line shows a negative association, the slope
should be downward
Total spending on two goods (X and Y) must equal the consumer’s
income, which can be expressed on the budget line. If we rearrange the budget line as a straight line wherein
y= a+ bx, the budget line will be:
The budget constraint equation can be expressed as:
Y = Income – Px X
Px X + Py Y = Income
Py Py
In this equation-
a= Income/Py or the Y intercept [the max Q of good Y that
• P is price the consumer can buy if all income is spent on Y]
• I is income b= Px/ Py or the slope [the trade off between the two
• X is the quantity of item X goods]

• Y is quantity of item Y X is the independent and Y is dependent variable

• Px denotes price of X item So we consider rearranging budget equation into y=a+bx

so that it can be drawn as a straight line and clearly see
• Py is the price of Y item. the intercept and he slope of the budget line
 Assessing Utility to Understand Preference and Optimization
Suppose Joe needs T-shirt this week and marginal utility of T-shirt for Consumer opts for an option where MRS is
him is twice the marginal utility of movie ticket. equal to the ratio of price [MRS= Px / Py]

So he would require two movie tickets to compensate for loosing one Since the MRS is also equal to the MU of two
t-shirt. In other words, Joe would need 2 units of movie tickets for commodities, it can be also expressed as:
losing 1 unit of t-shirt.
MUx / MUy= Px/Py

Marginal rate of substitution (MRS) equals the marginal utility (MU) of

one good divided by the MU of another good. This can be rearranged as: MUx / Px = MUy / Py
So, if Joe’s MU from one unit of movie is 5 utils and MU of one unit of t-
shirt is 10 utils, then-
Thus, at the optimum level, MU per $ spent on
good X equals the MU per dollar spent on good
a. MRS of T shirt for movie tickets will be: Y.
MRS (t-shirt, movie) = MUx (t-shirt)/ MUy (movie) = 10/5 = 2
In case it is not equal, the consumer could
b. We can also reverse the ratio and see MRS of movie tickets for T-
enhance their utility by spending –
shirts: - less on the good that provides lower MU per $
MRS (movie, t-shirt) = MUx (movie) / MUy (t-shirt) = 5/10= 0.5 and
- more on the good that provides higher MU per
dollar
Suppose Joe were offered 3 movie tickets in exchange of 1 t-shirt. Should
he accept this offer?
Measuring Utility
Suppose price of a t-shirt is Rs 10, and a movie ticket is Rs 5 while MU of a t-
shirt for Joe is 20 utils and MU of movie ticket is 5 utils. Joe is currently buying 1
t-shirt and 2 movie tickets.

Do you think Joe is maximizing his satisfaction at this combination? If not,

would you recommend him to spend more on t-shirts or more on movie
tickets?

MU per rupee from T-shirt= MUx(t-shirt)/Px(t-shirt)

20/10= 2
MU per rupee from movie= MUy(movie)/Py(movie)
= 5/5= 1
So Joe gets 2 units of utility for every 1 rupee that he is spending on t-shirt.
Income & Substitution Effect When Price of X commodity falls
Good Income Effect Substitution Effect Overall Effect

Good X Consumer has higher Consumer buys more X Income and substitution effects act
income or is rich so can as its relatively cheaper in same direction hence consumer
buy more of good X busy more of X good

Good Y Consumer has higher Good Y is comparatively Income and substitution effects act
income or is rich so can more expensive and in opposite directions. In this case,
buy more of good Y hence the consumer the total effect on consumption of Y
buys less Y. is ambiguous.

But what if the consumer has low income?

Giffen Good & Demand Curve
Can you think of an example when demand curve goes upward?
Economist Robert Giffen noticed about a possibility that violates the law
of demand wherein the demand curve moves upward
It happens in case one of the two goods fall in the category of Giffen Good
or an inferior good, often regarded as basic or primary commodity.
Suppose rice is the staple food for people in Alluri Sitaram Raju (ASR)
district. They like their rice with fish, vegies or meat.
Because of lower production, the price of rice increases this year.

In the graph, AB is the original budget line and AD shows the inward shift in
the budget line after rise in price of rice. Suppose, as the graph shows, common people in ASR are
now-
Earlier, an average household of 4 to 5 people in ASR was buying
- buying 45 kg rice (4 bags of 10 kg rice and 1 bag of 5 kg)
- about 35 kg rice [3 bags of 10 kg rice and 1 bag of 5 kg] and - buying less than 2 kg meat in a month now
- about 5.5 to 5.7 kg meat in a month.
So, the demand for rice is increasing with increase in price.
Now the price of rice increases while meat is stable. Price rise of this Giffen good is also impacting demand for
luxury good like meat.
What do you think the ASR households will do now?
Though price of meat is stable, people are cutting down on
Will they consider having more fish or vegetables or meat? Or may be buy meat to buy more rice.
other cereals like wheat or maize to substitute rice?
Giffen Good & Demand Curve
The recommended reading refers the example of Irish potato famine during 19th century when
people cut down on the luxury of buying meat to buy more potato, a staple food item for Irish
communities.

A 2008 study by Robert Jensen and Nolan Miller also reflects Giffen behavior wherein members
of low-income households prefer to purchase more quantity of primary commodities or staple
food items in case price of these commodities increases.

Jensen and Miller wrote, “To the best of our knowledge, this is the first rigorous empirical
evidence of Giffen behavior.”

Can you think of any examples that violate the law of demand?

Do you think such incidences are extremely rare?

Wage Affect
We discussed two good models. Can we consider time as a
resource that can be traded like other regular goods?

We have 24 hours in a day- we spend some of it in resting or

enjoying leisure and some to work so that we could earn and
spend on consumption and afford leisure.
Consumption Work
Do we think of trading time while determining our work
schedule? Income
Leisure
Suppose we need 10 hours to sleep and personal care and
are left with 14 hours- can we spend all 14 hours in doing
things that we enjoy and cherish? Or only on work and have
no time for leisure at all?

We work to earn and more hours of work will imply less or

fewer hours of rest and leisure.
Wage Effect
Suppose Neela is a freelance interpreter and earning $ 30 per hour for her
work.

She has 98 hours (14 hrs x 7 days) in a week- she can spend all of it to work and
earn $ 2,940 in a week.

But this will imply having no weekends, no time for family and friends or to for
watching movies or photography or any other thing that gives her joy.

If she decides to work 8 hours per day and have weekend, then she is working With rise in income, Neela can enjoy higher wages by consuming
for 40 hours and earning $1200 per week. more even if she continues working for 40 hours.
She can also either enjoy more leisure or consume more. She will
Now she has $1200 for consumption and 58 hours for leisure. Since she have to work more to have more for consumption.
prefers to consume more and have more time for leisure, her optimum point on
the indifference curves is usually at a higher level. Her decision between consumption and leisure determines her
labour supply.

Considering her budge constraint, she opts to work for 40 hours; earn $1200; Thus, with rise in income, we can see four scenarios here-
and have 58 hours for leisure. This is her optimum point on indifference curve - Hours of leisure increases
IC 1 - Hours of leisure decreases
- Supply of labour increases
- Supply of labour decreases
Suppose Neela’s wage increases from $ 30 to $ 40 per hour. Now she can earn Can you think of such scenario? Is it rare?
$ 3920 if she works for 98 hours and $ 1600 if she continues working for 40
hours. Do you think emotions, goals, passion, preferences etc. violate the
laws of demand & supply sometimes?
Rational Choice
Conventional economics assumes-
- individuals behave as rational decision makers
- Maximize utility (while recognizing constraints such as income
and prices)

This assumption is the foundation of the rational choice framework

in microeconomics

But does this happen in real world? Do people always make

decisions by carefully calculating costs and benefits?
Limits of Rationale Choice
Rationale choice theory assumes that consumers have-
- Stable preferences
- Complete information
- Consistent decision making capacity

But the real world is full uncertainties and consumers’ choices and preferences are also
neither static nor perfectly rational in most cases

Hence heterodox economists questions if the axioms of rationality always applicable

Debate around feasibility of the rationale choice theory have led economists to think of
alternative approaches that relax or reconsider the assumptions of rationale choice theory

It is apparent that economic behavior may not always follow the strict logic assumed in
classical models
Behavioral Aspect & Rational Choice
• Behavioral economics studies how people actually make decisions

• Individuals often depend on heuristics or mental shortcuts and not on elaborate or

complex calculations

• These shortcuts can lead to systematic biases in judgement and in decision making

• And these biases or perceived rationalities may prevent them from maximizing their
utilities or benefits or to reach at the optimum level of satisfaction

• Human behavior can be rational but not perfectly rational

• Humans are humans and, as feminist economists and heterodox economists have
pointed out, not Homo Economicus
 Production Possibilities Frontier (PPF & Social Choice)
Like individuals, societies also cant have everything- the budget constraint
cost applies here as well

So- society as a whole has to make choice- this can be understood through
the Production Possibilities Frontier (PPF).

Like budget constraint for individuals, the societies or countries cannot

achieve any level of production beyond the PPF.

David Ricardo used his famous two good model [On the Principles of Political
Economy and Taxation (1817)] to explain PPF, especially the trade off
between producing two goods with limited resources

The goods in consideration here are wine (Portugal) and cloth (England) and
his assumption is that if these two countries devote all their resources for the
production of one of these two goods then-
- Portugal can produce either 200 bottles of wine or 100 units of clothes
- England can produce 200 bottles of wine and 400 units of clothes.
 PPF

For England- For Portugal-

Maximum wine = 200 bottles Maximum wine = 200 bottles

Maximum Cloth= 400 units Maximum Cloth= 100 units

Intercepts of the PPF here will be: (0, 200) and (400, 0) Intercepts of the PPF here will be- (0, 200) and (100, 0)

Slope = 0- 200/400-0 Slope = 0- 200/100-0

= -200/400 = -0.5 = -200/100 = -2

So if England want to increase cloth production by 1 bolt, it will need to So if Portugal wants to increase cloth production by 1 bolt, it will
reduce the production of wine by 0.5 bottle need to reduce the production of wine by 2 bottles

Or for each additional bolt of cloth, England has to give up 0.5 bottles This implies for each additional bolt of cloth, Portugal has to
of wine. give up 2 bottles of wine.
PPF & Two Goods Model
• Both England and Portugal are producing equal amount of
wine. Clearly, they are good at producing wine. Shouldn’t
they focus on producing wine only?

• Suppose they both realize that they need cloth as well and
should produce some clothes too.

• They interact with each other to discuss and realize that

-Portugal will have to lose producing 2 bottles of`
wine if they produce 1 additional unit of cloth
- England will have to lose half (0.5) bottle of wine
if they produce 1 extra unit of cloth

• Now who should produce wine and who should produce

cloth?
PPF & Ricardo’s Two Goods Model
What if Portuguese wants to consume 100 bottles of wine and 100 units of
clothes without any external support? Can they have it while relying exclusively
on their domestic resources?

Similarly, can England manage on their own if they want to have 100 bottles of
wine and 300 units of clothes?

But what if they focus on their expertise- and Portugal produce only wine while
England produce only cloth? What will be the total production of wine and cloth
in this scenario?

Portugal can produce 200 bottles of wine, consume 100 bottles and sell the rest
100 to England- both the countries now can have the desired quantity of wine.

England can produce 400 units of cloth, consume 300 units and sell 100 unit to
Portugal- here also both countries are able to have the desired quantity of cloth

This can be expressed through: y= f(x)

This represents a production frontier where producing more of good x reduces
the possible production of good y.
PPF
So PPF shows the best combination of two goods for the consumer or the maximum
possible bundle of two goods that an economy can produce given its existing
resources and skill.

The key assumption in this case are:

- Economy is producing only two goods
- Resources are limited and fully and efficiently used for production
- Skills/technologies are fixed

Thus, PPF represents -

- Scarcity- resources are limited and producing only one good or more of one good
implies sacrificing another.
- Opportunity cost- quantity of one good that must be given up for producing another
good
- Efficiency- resources are not left unused and being efficiently used to maximize
production
Income & Substitution Effect When Price of X commodity falls
Good Income Effect Substitution Effect Overall Effect

Good X Consumer has higher Consumer buys more X Income and substitution effects act
income or is rich so can as its relatively cheaper in same direction hence consumer
buy more of good X busy more of X good

Good Y Consumer has higher Good Y is comparatively Income and substitution effects act
income or is rich so can more expensive and in opposite directions. In this case,
buy more of good Y hence the consumer the total effect on consumption of Y
buys less Y. is ambiguous.

Good X Consumer has lower Consumer buys more X

income or is poor and he as its relatively cheaper
can buy less of good X
Good Y Consumer has lower
income or is poor and can
buy less of
Feminist Economics
• Turn of the millennium witnessed feminists and heterodox economists
critiquing the biases within neoclassical economics

• Context of postmodernism and postcolonialism and emergence of

gender as an issue of academic discourse, including economics

• Focus on evidence reflecting class, race, gender-based divides

• Emergence of the feminist critique of economics- focusing on the

masculine or androcentric biases in the self-definition of the discipline,
its models, methodologies, teaching pedagogy etc.
Feminist Critique of Mainstream Economics
Feminist critique of economics highlighted that –

- Highly valued practice of economics are associated with masculinity and

men
- Over emphasis on objectivity, individual accomplishment, use of
mathematics often implies discouraging emptions and general human values
- Economic system includes homo economicus or self-interested individuals
who behave rationally
- Homo economicus’ decisions and preferences are shaped by their economic
rationality (comparing price, assessing opportunity cost etc.)
- Their preferences are stable and they are not influenced by external factors
such as communities, families, calamities etc.
Deconstructing the Rhetoric of Economics

• Feminist economists have critiqued mainstream economics tendency

to evade basic questions and silence non-mainstream approach of
addressing human or economic behaviour

• They critique mainstream approach of comprehending economics

through postcolonial and feminist lenses

• Focus on specific challenges women and gender minorities face in

entering labour market or enhancing their economic participation

• Advocate for economics that matters for all.

Feminist Critique
• While mainstream Economics considers human economicus or other hypothetical models
for understanding economic behaviour, feminist economists found this approach highly
problematic as “starting points matter”

• They underscored the implications of this approach on evidence, missing data as well as
reinforcing existing divides

• They emphasized over the human aspect of economics-and why it is important to focus on
this aspect

• The economic man was critiqued as “mushroom man” who seemed to have no childhood,
no old age, no other factors that influence their optimizing behaviour as a “rational adult”

• This approached missed care labor from the starting point- such crucial factors are left
outside of economic analysis