Indifference Curve Analysis and Budget Constraint Video Lecture | Economics for JAMB

in this podcast I'm going to talk about
consumer Theory again consumer theory is
really all about constrained buying I'm
going to introduce two topics and
difference curves and budget lines and a
difference curve looks something like
this and we plot quantity of good-y on
the y axis and quantity of good-x on the
x axis a couple of things we just need
to be aware of we talked about consumer
theory and one is the idea of transitive
preferences which means that if I prefer
chicken to beans and I prefer beef to
chicken
I prefer beef to beans one thing in
economics we have a hard time doing is
is actually putting numbers to things I
can say I prefer something more to
another thing I can say I prefer chicken
more than beans but it's hard to put an
actual empirical number on that we say
that more is better but there's also the
law of diminishing marginal returns
which says as I consume more steak enjoy
it less with each bite of a steak I take
I enjoy the steak less and less we often
talk about utility and by utility I mean
happiness and satisfaction this equation
is read as utility is equal to the
function of x and y utility is a
function of consumption of two products
x and y in this case X will be potatoes
and Y will be steak I've always had a
hard time just talking about products x
and y and we want to maximize utility
so imagine you have a giant stake a
friend of yours has a giant potato
you're going to trade how do you trade
if you have a lot of stake then you will
give up stake to get some potato
just to be clear this represents more
this represents less less and more on
the y-axis we have steak and on the
x-axis we have potato if I have a lot of
steak and I'm willing to give up steak
to get some potato in fact I'm willing
to give up in this scenario I'm willing
to give up a lot of steak to get a
little bit of potato
so in this case obviously I'm giving it
more steak and getting a little bit of
potato on the other hand if I don't have
very much steak and I'm down here at the
lower part of the curve then I'm willing
to give up a little bit of steak but I
expect to get a lot of potato as you
move down the curve notice that you
actually can serve or you can serve the
thing you have the least of so again I'm
good why we have a steak and good excess
potato and we look at slopes of lines
and that's what measures the trade slope
we call the marginal rate of
substitution it's a change in product Y
divided by the change in product X which
is the slope of the line is in this case
it's the change in a quantity consumed
of steak divided by the change in
quantity consumed the potato difference
curves are negatively sloped social
relationship trade between two goods in
this case x and y steak and potatoes
my budget curve it constrains my
consumption if I don't have a budget I
can consume as much as I want
so $5.00 per pound or potatoes expect
that assumption
let's make assumption that is $10 per
pound for steak and my income is $1,000
my equation looks something like this
$5 times the quantity of potatoes are
consumed and $10 times the quantity of
steak I consume and all that adds up to
my total income of $1000 what if I spent
all my income on steak then I cross out
that amount and I have $10 times the
amount of steak which means I can
consume 100 pounds of steak on the other
hand what if I spent all my income on
potatoes it looks something like this
and I have 200 pounds of potatoes a lot
of potatoes so we can plot this line if
I spin all on steak it's a hundred steak
all on potatoes is 200 potatoes I can
easily calculate the slope of your line
which is negative 1/2 the equation of my
budget line looks something like this
the price of x times the quantity of X
plus the price of Y times the quantity
of y
and we use em instead of I so we have
income is equal to price of x times the
quantity of X plus the price of Y times
the quantity Y and now we're going to
solve for y so we subtract the price of
x times the quantity of X from both
sides of the equation which gives us
income minus the price of x times the
quantity of X on the left hand side and
price of Y times the quantity of y on
the right hand side we divide both sides
by the price of y to isolate y which
gives us an equation like that and
eventually we have this equation here
again price of x times the quantity of X
plus the price of y times quantity of y
and all this adds up to income now when
we plot our equation and the budget line
or budget curve this is the where
equation works the slope of the line is
the ratio of the two prices and remember
that the the price of the goods we're
looking at is $5 and $10 and the price
the slope should equal 1/2 is what we
calculated before the slope of the line
is the ratio of the prices the slope
changes if the price changes
so now what happens if the price of
potatoes fall what we see is it moves
like that that means you can consume
more potatoes this it rotates around
that axis there you can buy more
potatoes what happens if the price of
potatoes rise you see you can buy less
potatoes and you pivot the other way buy
less of all potatoes what happens if the
prices take changes what we see is as
the price of steak goes down you can
actually buy more steak that's what the
prices tip goes down on the other hand
if the prices tick goes up you can buy a
less steak now the next question I have
is what kind of what happens if income
changes in this case if income goes up
the entire budget line shifts out right
buy more of everything
it can goes down you can buy less of
everything
so you see the entire shift of the line
income changes entire budget line shifts
income goes up budget line shifts out
work income goes down budget line shifts
inward so in the end we have constrained
consumption and we're going to draw a
lot of indifference curves that's called
a indifference map and we have a budget
line and we're going to look at what
happens when we combine these two
together in our next class but the key
is going to be the slope of the
indifference curve is going to equal the
slope of the budget line that's we're
going to maximize utility