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Econ 302 Lecture 6

 Indifference curve: The graphical representation of different baskets of commodities that the
consumer is equally happy with.
 It’s called an isoutility curve.
 All combinations generate same utility.
 U=XY is the indifference curve equation
 MRS xy is the slope of the indifference curve.
 MRS xy : The amount of Y that a person would give up to get one more of unit Y.
 Cobb-Douglas Utility Function: U=aXcYd , MRSxy= (c/d)(Y/x)
 C and D can be changed. C and d reflect the preferences between the two goods.
 Delta U/ Delta X=Mux
 DMU: The increase in utility attained from each unit increases at a decreasing rate.
 MRSxy= MUx/MUy
 MRSxy= delta Y/delta X
 This is read as x for y, if they ask popcorn for lemonade, take popcorn as x(for Px/Py)
 Perfect Substitutes: Here we don’t see a diminishing MRS trend. It’s a straight downward
sloping line.
 Perfect Complements: Infinite slope and a slope of 0, they are in L shapes, (o or infinite slope is
also correct) / Basically, if they lose one unit of x, then y can’t be used so diminishing MRS
doesn’t work here.
 Budget constraint- Limitation of consumer’s preferences.
 Market Rate of Substitution: - Px/Py( Slope of the budget constraint)
 The rate at which one good can be traded for another good is market rate of substitution.
 Efficient combination/ Optimization Condition: The point where IC and BC meet. MRS=MrktRS
 Px/Py= MUx/MUy (Optimization condition)
 Use Budget equation and optimization condition to solve for X and Y
 Indifference Curve Shapes
o When both are normal goods, the curve is downward sloping, convex
o When one good is bad, upward sloping
o When one good is neuter, if on x axis, horizontal, if on y, vertical graph
 Corner Solutions:
If the slope of the indifference curve is steeper than the budget line the consumer is willing to
give up more of y for a unit of x than the market requires.

Slope of Indifference curve > Slope of the budget line

That means the consumer wants more and more of x,x,x,x,x


Thus, we end up with a corner solution (x intercept).

If the slope of the indifference curve is flatter than the slope of the budget line, the consumer
is willing to give up more and more units to get a unit of y.

Slope of Indifference curve < Slope of Budget line


That means the consumer wants more of y
We end up with a corner solution at the y intercept

 Budget line and it’s shifts


o If Px increases:
o If Py increases, the y intercept shifts up
o And vice-versa
o The budget line completely shifts when the income of a consumer rises or
falls.
 If INDIFFERENCE CURVES CROSS< THE TRANSITIVITY ASUMPTION IS VIOLATED!!!!!!!
REMEMBER

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