What is Marginal Utility? | What is Indifference Curve? | What is Indifference Map? | What is Law of Diminishing Marginal Utility? | What is Marginal Rate of Substitution? | What is Law of Diminishing Marginal Rate of Substitution? | What are Monotonic Preferences? | What is Indifference Map? | What are features of Indifference Curve? | What is Budget Set and Budget Line? | Changes in Budget Set | Consumer’s Optimal Choice.
This session is summary of all the concepts discussed in detail in previous sessions till now, which are fundamental to decision regarding optimal choice of the consumer.
In previous sessions, we discussed in detail about the
consumer choice. We started with the meaning of bundle of goods which refers to
a combination of goods or commodities that the consumer can buy with the
available means and resources here, income. Consumer chooses bundle which give
maximum utility to them. Bundles are different combination of goods and hence
there can be several bundle and out of those, there can be combinations which
can give equal utility to consumer in totality even if component of those
bundles may not be exactly equal and same.
What is Indifference Curve?
The curve on a graphical representation showing all those
points of bundles among which the consumer is indifferent to consume from is
known as an indifference curve. The consumer is indifferent because even as the
component of bundles may vary but the total utility of all of those bundles
would be same and hence consumer would be indifferent between them.
What is Marginal Utility? | What is Law of Diminishing
Marginal Utility?
The utility or level of satisfaction received from one more
additional unit of a particular good is termed as Marginal Utility. And as the
number of additions increases, the marginal utility from each additional unit
keeps on decreasing which we call as Law of Diminishing Marginal Utility. And
as the consumers receives less utility from each additional unit, they will
also pay less for that additional unit. This is the reason why the demand curve
is downward sloping.
What is Marginal Rate of Substitution? | What is Law of
Diminishing Marginal Rate of Substitution?
Consumers even substitute one good of the bundle with the
other. But that depends again on several factors including the level of utility
those goods provide, etc. The rate at which the consumer is willing to
substitute one good for the other in such a manner as to keep the level of
total utility same or equal is known as Marginal Rate of Substitution. But
Marginal Rate of Substitution keeps on falling because with each round of
exchange, the concept of Marginal Utility and Law of Diminishing Marginal
Utility comes at play. Suppose A is exchanged for B. With each exchange, the
additional utility of B falls and the utility of remaining A increases. This
phenomenon is known as Law of Diminishing Marginal Rate of Substitution.
Shape of Indifference Curve
The Law of Diminishing Marginal Rate of Substitution results
in the indifference curve being convex to the origin in the graphical
representation. But in cases where the goods are perfect substitute of each
other which means any number of exchanges between those goods keeps the total
utility equal as both goods have equal utility or level of satisfaction thus
making no difference to consumer with any number of exchanges, the shape of
indifference curve is a straight line.
It is important to note that consumer always prefers a
bundle having more quantity of a particular good till that good gives positive
marginal utility. Suppose a bundle is having Apples(A) and Bananas(B) as two
good. Now assume it has quantity (A, B) as (2, 3). Now let’s introduce one more
bundle having more Apples and same bananas as (3, 3). So here it is always
given, that the consumer will prefer the later bundle with additional apple
(more of a good) with other good being no less than the first bundle. Such
preference of bundle is known as Monotonic Preferences. So between two bundles,
consumer will prefer a bundle with more of one good with other being no less
than first bundle.
What is Indifference Map?
These preference thus shifts the bundle with more quantity
of goods to higher level as they provide greater utility to the consumer. And
hence such bundles lie on higher indifference curve than the bundles with lower
quantity giving lesser utility or satisfaction. And hence we derive several
indifference curves showing all the bundles having different combination of
goods and such a family or set of indifference curves is called an Indifference
Map. And bundles on higher indifference curves are always preferred and are superior
as compared to bundles on lower indifference curves.
What are features of Indifference Curve?
We can describe the features of indifference curves as
follows;
1) (1) Indifference Curve is downward sloping from left
to right
2) (2) Higher Indifference curve denotes greater
utility level to the consumer
3) (3)Two Indifference Curves cannot intersect each
other.
What is Budget Set and Budget Line?
The group or set of bundles which are available to consumer
for consumption is called Budget Set. It includes all the bundles which the
consumer can afford to buy. Thus all the bundles in the budget set costs either
less than or equal to the income of the consumer. There is a demarcation here.
The line on the graph of budget set which shows those bundles with costs
exactly equal to the income of the consumer is known as the Budget Line. The
slope of the budget line finds its origin from the price ratio of goods i.e.,
at what price the consumer is able to switch quantities of goods within the
bundle given the market price of those goods and the income of the consumer.
Changes in Budget Set
The budget set and the budget line showing the affordability
of the consumer keeps on changing in real life. As we saw there are two main
factors which decide the budget set as well as budget line which are the market
price of the goods and the income of the consumer. And both of these factors
changes with time. And hence it becomes important to study the changes in the
budget set which results from the changes in the factors. If the income of the
consumer changes, the budget line shifts either outward (if income of the
consumer is increased) or inward (if income of the consumer decreases).
Similarly, if the price of the goods increase or decrease, the budget line will
pivot from that intercept representing that particular good either inward or
outward.
The budget set represents several bundles of goods and now
the problem of the consumer arises as to which bundle should be the optimum
bundle to be chosen by the consumer for consumption. In graphical term, which
point in the graph representing budget set and budget line should be the
optimum point of bundle, which gives maximum satisfaction to the consumer. This
problem is problem of Consumer’s Choice.
Consumer’s Optimal Choice
The optimal point or bundle or choice of the consumer is the
point of tangency of budget line to the indifference curve. The reason being,
at the point of tangency the absolute value of slope of indifference curve as
decided by the Marginal Rate of Substitution and the absolute value of slope of
the budget line as decided by the price ratio of goods is equal or same. The
former shows the preference or willingness of the consumer and the later shows
the ability of the consumer to buy that bundle. And the optimal choice of the
consumer will be the point at which the willingness or preference meets the
ability or affordability of the consumer.
Conclusion
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