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OSU ECON 4001.01 - Indifference Curves

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Econ 4001 1st Edition Lecture 4Outline of Last Lecture II. Equilibriuma. Surplus definitionb. Shortage definitionIII. Conditions for Perfect CompetitionIV. Response to shifts in supply and demand curvesV. Predicting Price and Quantity responses in curve shiftsVI. Point Elasticity vs. Arc ElasticityVII. Other Elasticitiesa. Long run vs. short runb. Income ElasticitiesOutline of Current Lecture VIII. Where demand comes fromIX. What the goal of consumption isX. Market Baskets and Consumptiona. Indifference CurvesXI. Marginal Rate of Substitutiona. Perfect Substitutes and ComplementsXII. Budgets and Limited ResourcesXIII. Budget Linesa. Impact of change on the budgetb. Combining indifference curves and budget linesXIV. Maximizing Consumer SatisfactionCurrent Lecture- Where does demand come from?o Tastes and consumer satisfaction drive demando Demand curves come from willingness to payo Many questions arise from the demand curve such as What makes us willing to pay a certain amount? Why do different people have different demands?o These questions will be answered in this lecture- What is the goal of consumption?These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.o The goal is to increase our well-being, satisfaction, and happiness (the term “utility” is often used in economics for this)o Basic assumptions for consumption Consumers prefer more to less Consumers have a taste for variety Scarcity means that we cannot consume all that we want  must make choiceso Implication: consumers will choose a basket of goods that maximizes satisfaction subject to their budgets- Market Baskets andConsumption graphically represented with Indifference Curveso Indifference Curve: according to this curve, any point on here consumers would be indifferent to, but a point above is preferredo Multiple indifference curves: each curves have points that people are indifferent to, but the curve closest to the origin is the least satisfactory (farther away from origin: more satisfactory)o Indifference never intersect If they did intersect, one indifference curve would have more and less satisfaction at the same time and that is impossibleo The shape of the curve tells us the relative value- Marginal rate of substitutiono This law implies that as you consume more and more of good 1, you are willing to give up less and less of good 2o Perfect substitutes: straight lines (example: apples and oranges)o Perfect compliments: L-shaped lines (examples: right and left shoes)o For both perfect substitutes and compliments the marginal rate of substitution is constanto Indifference curves can be quantified by “utilities” or sometimes called “utils”- Budgets and Limited Resourceso Consumption basket includes everything a person chooses to purchase and consumeo Some elements of the basket may be very high cost- houses, automobiles, college education o Budget line is always a straight lineo Equation: (PGood1xGood1)+(PGood2xGood2)= I (Income)- Budget Lineso Impact of change in income on budget line Income changes cause a parallel shift in the budget line; higher income moves budget away from the origino Impact of change in one price on budget line Price increase causes a pivot in the budget line from the origin- Combining indifference curves and budget lineso Consumption basket will always be on the budget line (cannot over consume outside the line because not enough money/always use all the money so there is no under consume)- Maximizing Consumer Satisfactiono Find the point on the budget line that is tangent to the highest indifference curves (more satisfaction on higher I.C.)o Properties of an optimal consumption basket Consumer cannot achieve higher utility/satisfaction without an increase in budget Price changes in one or both of the goods will cause a shift from the optimal pointo Marginal costs equal marginal benefits for both


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