- Indifference curve
- An indifference curve shows combinations of two goods that provide an equal level of utility or satisfaction to one person.
- Budget constraint
- A budget constraint shows every combination of two goods a person can afford, given their prices and the income there is to spend.
How a person trades one good for another
Can you name the three ideas that give an indifference curve its shape?
At A-level, utility is counted in utils. An indifference curve drops the numbers: it needs only that a person can say which of two bundles they prefer, or that they do not mind. These three ideas follow from that.
The marginal rate of substitution is the rate at which a person is willing to trade one good for another so that utility remains the same.
Can you think of an example?
If you would give up two doughnuts for one more book and feel no better or worse off, your marginal rate of substitution is two doughnuts per book. It is the slope of your indifference curve, without the minus sign.
A diminishing marginal rate of substitution means that the more of one good a person has, the less of the other they will give up for one more unit of it.
Can you think of an example?
With a few books and plenty of doughnuts, one more book is worth a lot of doughnuts. With a shelf full of books and few doughnuts, it is worth hardly any. That is why the curve is steep on the left and flat on the right.
An indifference map is the whole field of a person's indifference curves, one for every level of utility, with higher curves giving more utility.
Can you think of an example?
Take any point on a lower curve and you can find a point on a higher one with more of both goods. So every point on the higher curve beats every point on the lower one, and two curves can never cross.