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ABM 311 (Introductory Microeconomic Theory) 1. Module 3 Consumer Choice and Demand: The Indifference Curve Approach

This document provides an overview of Module 3 of the course ABM 311 (Introductory Microeconomic Theory). [1] It discusses consumer choice and demand using the indifference curve approach. [2] Specifically, it covers defining and drawing indifference curves and budget lines, and determining consumer equilibrium where the slope of the indifference curve equals the slope of the budget line. [3] The document explains key concepts like indifference curves, budget constraints, marginal rate of substitution, and how changes in prices and income affect consumer equilibrium.

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Irene Pacunayen
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© © All Rights Reserved
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Download as DOCX, PDF, TXT or read online on Scribd
61 views

ABM 311 (Introductory Microeconomic Theory) 1. Module 3 Consumer Choice and Demand: The Indifference Curve Approach

This document provides an overview of Module 3 of the course ABM 311 (Introductory Microeconomic Theory). [1] It discusses consumer choice and demand using the indifference curve approach. [2] Specifically, it covers defining and drawing indifference curves and budget lines, and determining consumer equilibrium where the slope of the indifference curve equals the slope of the budget line. [3] The document explains key concepts like indifference curves, budget constraints, marginal rate of substitution, and how changes in prices and income affect consumer equilibrium.

Uploaded by

Irene Pacunayen
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Introductory Microeconomic Theory

ABM 311 (Introductory Microeconomic Theory)

1. Module 3 Consumer Choice and Demand: The Indifference Curve Approach

2. Introduction
This module covers the use of indifference curves as an approach in analyzing consumer
behavior. It discusses the concepts of indifference curves and budget lines and their use in
finding the optimal combination of goods.

3. Learning Outcome

After finishing Module 3, it is expected that your skills in reading, analyzing and drawing
graphs would have improved. Specifically, you are expected to be able to:

1. Define and describe indifference curve


2. Discuss and sketch budget lines
3. Determine consumer equilibrium

4. Learning Content

An Indifference curve is a curve that shows the combinations of goods that give a consumer the
same level of satisfaction. In the graph that follows, functions I 1 and I2 are indifference curves.
Each curve shows a set of combinations of quantitites of products X and Y that give a consumer the
same level of satisfaction or utility. For instance, point D (1 unit of Y and 3 units of X ) and point E
(3Ys and 1 X) are along the same indifference curve I 1 and therefore provide the consumer the same
level of satisfaction. Combinations A, B, and C along Indifference curve 2 represent higher quantities
of X and Y that yield the same level of satisfaction. The higher the indifference curve, the higher the
level of satisfaction or utility because the consumer is assumed to prefer more of goods to less of
these.

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Introductory Microeconomic Theory

The indifference curve can be described as : a) downward sloping to the right; b) convex to the
origin; and c) non-intersecting. These characteristics are explained by the following assumptions
regarding consumer preference ordering :
1. Completeness. It is assumed that the consumer is capable of expressing a preference for or
indifference among bundles of goods. For example, given two bundles of goods say tarts(T) and
chocolates(C ), the consumer can express his preference as either T>C (T is preferred to C) ,
C> T(or C is preferred to T) or T= C (or consumer is indifferent )
2. More is better. The consumer is assumed to prefer more of the good to less of it. In the graph,
bundle A is preferred to bundle E because it has the same amount of good X but more of good
Y. Bundle B is also preferred to bundle E because it has more of both goods X and Y. This
explains why the relevant portion of the indifference curve is downward sloping. To remain in
the same level of satisfaction, a consumer is willing to reduce the quantity of one good ony if this
is compensated for or replaced by an increase in the other good.
3. Diminishing Marginal Rate of Substitution(MRSxy) states that as a consumer obtains more of
good X, the amount of good Y he or he is willing to give up for an additional unit of X decreases.
This explains why the indifference curve is convex to the origin.
Marginal Rate of Substitution – the rate at which a consumer is willing to substitute one
good for another good and still maintain the same level of satisfaction.
4. Transitivity. For any three bundles, A, B and C, logic tells us that if A > B and B>C, then A>C.
This assumption of transitive consumer preferences explains why indifference curves can not
intersect. When indifference curves intersect, this assumption is violated. In the graph below for
instance, if A=C and C=B then A=B. But this can not be because A represents more goods than B
and so A is preferred to B (or the consumer can not possibly be indifferent between A and B or
A=B)

CONSTRAINTS
In making decisions, consumers are sometimes faced with legal constraints, time constraints,
physical constraints, and budget constraints. Budget constraints refer to constraints influenced by
income and prices of goods.

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Introductory Microeconomic Theory

Budget set (opportunity set) shows the combinations of goods that are affordable to the consumer.
Budget line – shows the bundles of goods that exhaust a consumer’s income.
Suppose given the consumer;s income (M) and price of good X (Px) and price of good Y (Py),
the budget set may be expressed mathematically as:
Budget Set : Px X + Py Y ≤ M
Budget Line : Px X + Py Y = M

Effects of a change in income on the budget line

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Introductory Microeconomic Theory

Example: Given consumer’s income (M) = Php2,000; Px = Php500.00; Py = Php 200.00


Required: 1. Draw the budget line and label it as BL 1.
2. Draw the new budget line if the price of good X increases to Php 1,000 whille M and
Py remain the same. Label this as BL2.

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Introductory Microeconomic Theory

CONSUMER EQUILIBRIUM
The consumer is said to be in equilibrium when he has no incentive to change to a different
affordable bundle. The equilibrium consumption bundle is the affordable bundle that yields the
highest level of satisfaction to the consumer. It is the bundle at which the slope of the budget line is
equal to the slope of the indifference curve.

At consumer equilibrium,
Slope of the indifference curve = slope of the budget line
MRSxy = Px/Py

5. Recommended Learning Materials and resources for supplementary reading

Video lesson https://youtu.be/-IzoID3Bx-0

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