Consumer preferences and indifference curves. The properties of indifference curves. Marginal rate of substitution.

Consumers’tastes can be examined with ordinal utility. An ordinal measure of utility is based on three assumptions. First, we assume that when faced with any two baskets of goods, the consumer can determine whether he or she prefers basketAto basketB, BtoA, or whether he or she is indifferent between the two. Second, we assume that the tastes of the consumer are consistent or transitive. That is, if the consumer states that he or she prefers basket A to basket B and also that he or she prefers basket B to basketC, then that consumer will prefer A to C. Third, we assume that more of a commodity is preferred to less; that is, we assume that the commodity is a good rather than a bad, and the consumer is never satiated with the commodity. The three assumptions can be used to represent an individual’s tastes with indifference curves. In order to conduct the analysis by plane geometry, we will assume throughout that there are only two goods, X and Y

An indifference curve shows the various combinations of two goods that give the consumer equal utility or satisfaction. A higher indifference curve refers to a higher leve of satisfaction, and a lower indifference curve refers to less satisfaction. However, we have no indication as to how much additional satisfaction or utility a higher indifference curve indicates. That is, different indifference curves simply provide an ordering or ranking of the individual’s preference.

Characteristics of Indifference Curves. Indifference curves are usually negatively sloped, cannot intersect, and are convex to theorigin. Indifference curves are negatively sloped because if one basket ofgoods X and Y contains more of X, it will have to contain less of Y than another basket inorder for the two baskets to give the same level of satisfaction and be on the same indifference curve.

A positively sloped curve would indicate that one basket containing more of both commodities gives the same utility or satisfaction to the consumer as another basket containing less of both commodities (and no other commodity). Because we are dealing with goods rather than bads, such a curve could not possibly be an indifference curve.

Indifference curves also cannot intersect. Intersecting curves are inconsistent with the defi nition of indifference curves.

Indifference curves are usually convex to the origin; that is, they lie above any tangent to the curve. Convexity results from or is a refl ection of a decreasing marginal rateof substitution, which is discussed next.

The Marginal Rate of Substitution. The marginal rate of substitution (MRS) refers to the amount of one good that an individual is willing to give up for an additional unit of another good while maintaining thesame level of satisfaction or remaining on the same indifference curve.