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Define indifference curve and budget lines.
1. Indifference curves are curves which show all of the combinations of two goods
that give the consumers equal satisfaction or utility. It is also called the Iso-Utility
curve. It is basically a locus for these points.
2. Budget lines are lines which represent all the possible combination of 2 goods
which can be bought by the consumer at a given price for 2 goods and income
level All combinations on the curve represent the total income being spent shows consumption being maximised at this point.
Why are ICs downward sloping
They are downward sloping since the increase of one good leads a decrease in
consumption for the other good. this is there to maintain the same utility because if there
is rise of both that means more utility is gained and indifference isn’t present. when one
increases, quantity of other decreases at a declining rate.
What is an indifference map & why can’t ICs Meet ?
it is a family of indifference curves. Low curves show low utility. higher show higher. One
indifference curve never intersects the other because then that means same utility is
gained and is different from other points but at an indifference curve by the very
definition same utility is gained throughout
Rational consumers always go for the higher ICs. only in irrational consumers can ICS
intersect.
Define and explain the use of monotonic preferences
States that a rational consumer always prefers more of a commodity as it offers them a
higher level of satisfaction. C RISE = TU RISE. → ONLY THERE WHEN :
in b/w any 2 bundle of goods, he prefeers the bundle which has more of at least one of
oof the goods and no less of the other good. example : eg : (a) : 10Y 10X and (b) 7Y 7X.
Bundle (a) is the monotonic preference since more of both. This explains why higher ICs
lead to higher utility since shows a greater bundle of goods.
What is MRS and why is it important ?
MRS (Marginal Rate of Substitution) = Sacrice of B/Gain of A when MRS is related to A.
= slope of IC = derivative at point since declining leads a convex shape.
MRS helps to show how the Law of DMU is applied TO ICs where as more of A and less
of B, utility of B is greater or more of A is given - however as more of B is consuemd as
opposed to a it’ utility declines and willigness to give up A for B due to lwoer
consumtoion declines and leads to declining MRS.
What are the causes for the shifts in the budget lines.
1. Substitution Effect : change in Price of good x and not of good y if it becomes
cheaper leads to higher consumption of good x as rational consumers always
substitute towards relativty cheaper goods
2. Income Effect : Real incomes are actually increases as consumer is able to
purchase of the relatively more of the good x. this refers to as income effect of
price change.
What are the limitations of the curve ?
1. There are more than 2 goods to choose from.