Lecture 15

• Higher indifference curves are preferred to lower ones - consumers prefer to have more of something.
• Indifference curves are downward supplying - consumers are willing to give up some good only if they get some other good in return.
• Indifference curves do not cross.
• Indifference curves are bowed inwards - consumers are more willing to trade away goods they have in abundance.

Perfect substitutes are goods with straight-line indifference curves. As a result, the marginal rate of substitution is constant. For example, nickels and dimes.
Goods with right-angle indifference curves are perfect complements. For example, left shoes and right shoes.

A point at which the budget constraint curve and indifference curve touch (tangentially) is known as the optimum.
Therefore, the consumer chooses to consume such that the marginal rate of substitution is equal to the relative price. We are just equating the slope of the indifference curve and the slope of the budget constraint. At the optimum, the valuation of the two goods equals the market’s valuation.

An increase in income shifts the budget constraint curve outwards.

The substitution effect is the change in consumption that occurs when a price change moves the consumer along an indifference curve to a point with a different marginal rate of substitution (along the indifference curve).
The income effect is the change in consumption that occurs when a price change moves the consumer to a higher or lower indifference curve.