CHAPTER FIVE

5 Introduction
to Microeconomics
Samuelson, Paul A.
William D. Nordhaus
19th Edition

Appendix Ch.5
A Graphical Representation
of Consumer’s Choice Problem
Spring 2020 1
Consumer Choice Problem:
Recall that demand depends on preferences,
income and prices of goods and services.
Required ingredients to be able to determine
how the final quantities of goods C and F will
be chosen:
1. Consumer Preferences
2. Budget constraint: in terms of income and prices
I. Consumer Preferences: Indifference Curves

An indifference curve is a curve representing different

consumption bundles among which the consumer is
indifferent i.e. all are equally desirable (all give same
level of utility).
I. Consumer Preferences: Indifference Curves
An Indifference curve is convex to the origin:
This means that absolute value of slope of the IC curve
decreases (curve gets flatter), as we move to the right;
reflecting a property called the law of diminishing
marginal rate of substitution MRS.
MRS: measures how a person substitutes one good for
another.
The scarcer a good, its marginal utility is higher
relative to the marginal utility of the good that has
become plentiful (the greater its MRS).
As more of one good is consumed, the consumer
would prefer to give up fewer units of a second good
to get additional units of a first good.
I. Consumer Preferences: Indifference Curves
From the previous graph, moving from A to B, you
would swap 3 of your 6 clothing units for 1 extra food
unit. But from B to C, you would sacrifice only 1 unit of
your remaining clothing supply to obtain a third food
unit (a 1-for-1 swap).
If we join the points A and B, we find that the slope of
the resulting line (neglecting its negative sign) has a
value of 3. Join B and C, and the slope is 1; join C and D,
and the slope is ½.
These are the marginal rates of substitution between the
two goods.
Slope of the indifference curve (∆ ⁄∆ ) gives this MRS.
Deriving an expression for the slope of IC:
Look at the arc between A and B.
We know that moving from A to B, total utility
remains constant.
That is, the marginal utility lost from consuming
less of C must be matched by the marginal utility
gained from consuming more of F:
. ∆ = −( .∆ )
Rearranging terms, we obtain:
∆
= −( )
∆
The Indifference Map
II. Consumer Budget Line: Income & Prices

Now let us set a particular consumer’s indifference

map aside for a moment and give the consumer a
fixed income.

He has, say, $6 income per day to spend, and is

confronted with fixed prices for food and
clothing—$1.50 for food, $1 for clothing.

To draw the budget line, we need to get two points;

horizontal intercept and vertical intercept.
II. Consumer Budget Line: Income & Prices

The budget line NM has all possible combinations of

the two goods that the consumer could afford using all
his income.
The consumer is free to move anywhere along NM.
Positions to the right and above NM are not possible
because they require more than $6 of income;
Positions to the left and below NM are irrelevant
because the consumer is assumed to spend the full $6.
The slope of NM is − :
( ÷ = × =− =− .
This means that, given the goods prices, the consumer
gives up 3 units of clothing to get 2 units of food.
 III.Equilibrium:
Now we are ready to put our two graphs together:
III.Equilibrium:
The previous Figure demonstrates our consumer
problem:
A consumer will choose from among affordable
combinations the one that maximizes utility.
Graphically, the consumer will move along the
budget line until he is on the highest indifference
curve.
This happens at point B in the figure.
At this point, the budget constraint is just tangent
to the indifference curve
III.Equilibrium:
In other words, consumer equilibrium is attained at the
point where the budget line is tangent to the highest
indifference curve.
At B, the budget line just touches, but does not cross,
the indifference curve U3 .
Implications of the tangency condition:
When two curves are tangent, they have the same
slope.
Geometrically, the consumer is at equilibrium when
the slope of the budget line ( ) is exactly equal to
the slope of the indifference curve ( ).
III.Equilibrium:
Equilibrium Condition:
In equilibrium, the consumer is getting the same
marginal utility from the last penny spent on food
as from the last penny spent on clothing.
Tangency condition states that the ratio of prices
must be equal to the ratio of marginal utilities;
Equilibrium condition:
Applications: Changes in Income and Price
1. Income Change

Assume, first, that the consumer’s daily income is

halved while the prices of the two commodities
remain unchanged.

The budget line thus makes a parallel shift inward.

Implication: new utility-maximizing consumption

bundle will be chosen.
Income-Consumption Curve:

The dark pink curve in the previous graph

represents the Income-Consumption Curve.

Income-Consumption Curve traces out the

utility maximizing consumption bundles
associated with each income level.
Applications: Changes in Income and Price

2. Single Price Change

Assume that the price of food rises from $1.50 to $3
while the price of clothing is unchanged.

What will be the impact on the budget line?

This time we find that the budget line will pivot on

point N.

Implication: new utility-maximizing consumption

bundle will be chosen.
Price-Consumption Curve:
Price-Consumption Curve traces out the utility
maximizing consumption bundles for each price of
food.

Price-Consumption Curve is the dark pink curve

in the previous graph.
DERIVING THE DEMAND CURVE
Look carefully at the previous figure:
As we increased the price of food from $1.50 to $3, we
kept other things constant:
Tastes represented by indifference curves did not
change,
money income and price of clothing stayed
constant.
Therefore, we are in the ideal position to trace the
demand curve for food:
At a price of $1.50, the consumer buys 2 units of
food, shown as equilibrium point B .
When the price rises to $3 per unit, the food
purchased is 1 unit, at equilibrium point B”.
DERIVING THE DEMAND CURVE

Now plot the price of food against the purchases of

food, again holding other things constant.
You will have derived a neat downward-sloping
demand curve from indifference curves.
Note that we have done this without ever needing to
mention the term “utility”—basing the derivation
solely on indifference curves.
Thank You
Best of Luck