Indifference curves and budget lines
Indifference curves and budget lines
- An indifference curve shows all combinations of two goods giving the same total utility (downward, bowed to the origin).
- A budget line shows all combinations the consumer can just afford.
- Consumer equilibrium = where the budget line just touches the highest reachable indifference curve.
Practice
An indifference curve shows combinations of two goods that give:
Every point on one indifference curve gives the consumer equal total utility.
Practice
Consumer equilibrium is where the budget line:
The best affordable choice is where the budget line just touches the highest indifference curve.
Income and substitution effects
- When a price falls, the consumer buys more for two reasons:
- substitution effect — it's now cheaper than other goods, so switch towards it,
- income effect — real income rises, so they can buy more.
- normal good — both effects raise quantity. inferior good — income effect works against, but is weaker. Giffen good — income effect so strong that demand falls when price falls.
Practice
A Giffen good is unusual because, when its price falls, demand:
For a Giffen good the strong negative income effect outweighs the substitution effect, so demand falls when price falls.
You've got it
Key idea
- an indifference curve = equal utility; a budget line = what's affordable
- consumer equilibrium = budget line tangent to the highest indifference curve
- a price fall = substitution + income effect; a Giffen good breaks the rule