Preferences And Indifference Curves

Lesson: Preferences And Indifference Curves

Lesson Developers: Vaishali Kapoor And Rakhi Arora

College/ Department: Delhi University

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 Preferences And Indifference Curves

Table of Contents:
1. Introduction
2. Preferences
2.1 Axioms of Preferences
2.1.1 Complete
2.1.2 Reflexive
2.1.3 Transitivity
3. Utility
3.1 assigning utility
3.2 Positive Monotonic transformation
3.3 total and marginal utilities- one good case
4. Indifference Analysis
4.1 Well behaved Indifference curve
4.2 Properties of Indifference curves
4.2.1 Negatively sloped
4.2.2 Thinner lines
4.2.3 Convexity
4.2.4 Indifference curves don’t intersect
4.3 Well behaved preferences and Indifference curves
4.4 satiation point
4.5 Marginal Rate of Substitution
4.6 Special cases of preferences and their indifference curves
4.6.1 Neutral good
4.6.2 Perfect substitutes
4.6.3 Perfect Compliments
4.6.4 Cobb Douglas Preferences
4.6.5 Discrete goods
5. Summary
6. Exercises
7. Glossary
8. Appendix
9. References

Learning Outcomes:
After studying this chapter, a student should be able to:-

1. Explain rational behavior of a consumer.

2. State axioms of preferences.
3. Define utility function.
4. List properties of Indifference curve.
5. Sketch indifference curve map for every preference.
6. Calculate and interpret slope of indifference curves.
7. Define satiation point.

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1. Introduction
Consumers are rational decision makers in the sense they know their preference over goods
and buy goods that get them maximum satisfaction. In this chapter we will assume
consumers to be rational and study preferences and utility derived from various bundles of
commodities. Only difference between actual consumer in the market and our study is that
here we would have calculus applied to the situations consumer faces in the market.

This chapter is divided into three sections. First section covers axioms of preferences. In the
second section, utility function is derived. In the last section, indifference curves are
detailed at length.

2. Preferences
If I ask you, what would you like to have in dinner: fried rice or chowmien? I would receive
three of these answers: (a) fried rice, (b) chowmein, (c) either of these. Irrespective of your
answer choice, I would conclude something about your preferences either you like fried rice
over chowmein or chowmein over fried rice or like both equally. As in this example
commodities are ordered/ranked so could be bundles of commodities.

2.1 Axiom of preferences

While ranking of commodity bundles, consumer should, however follow some logical
reasoning, and we can say a consumer is rational and consumer’s preferences are
consistent. Following are listed few of the assumption about consumer preferences which
are called axioms of consumer theory.

Let us understand the notation used for it. ’>’ symbol is used when one bundle is strictly
preferred over other.’~’ symbol is used when two bundles give equal level of satisfaction to
the consumer. When consumer prefer or is indifferent between two bundles over other and
≥ symbol is used to compare two same bundles.

2.1.1 .Complete

Axiom of completeness states that two bundles can be compared. Assume two bundles 1
and 2; both comprising of gods x and goods y.

(a) Either (x1,y1) would be preferred over (x2,y2) : (x1,y1)≥(x2,y2)

(b) Or (x2,y2) would be preferred over (x1,y1) : (x2,y2)≥(x1,y1)
(c) Or both, which means that you consumer is indifferent between two bundles.

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2.1.2 Reflexive

If a bundle is as good as itself then it follows reflexive. For example: a cold drink bottle on
left is as good as on the right. Both the bundles contain one cold drink bottle. For kid, this
sort of assumption could seen invalid but not for adult, at least.

2.1.3 Transitivity
If bundle 1 is preferred over bundle 2 is preferred over bundle 3. Suppose you prefer
studying in India over US and US over Australia, then it seen that given all three choices,
you must choose India

This assumption help in forming best bundle choice.

Example 1

Consider the following binary relation defined over where x is set of human beings. Check if
each of these relations satisfies reflexivity, completeness and transitivity.

i). At least as tall as

Assume three individual; A,B,C

A could be taller than, shorter than or of same height as of, B.

A is at least as tall as B could be used in first & third instance or B is at least as tall as a
can be used is second & third instance. Since, this relation helps is comparing A & B. This
relation is complete.

A is at Least as tall as a also makes sense hence this relation is reflexive.

If A is at least as tall as B, & B is at least as tall as C then A is at least as tall as C. Even if

three would of same height this statement would still hold. Hence, this relation is
“transitive.

ii) ‘Taller Than’

A could be taller than, shorter than or of same height as of, B.

This relation is not complete since is third case of same height this relation last be used. It
is not reflexive since A can’t be taller than her/herself.

If A is taller than B & B is taller than C then it follows that A is taller than C. So this
relation is transitive.

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3. Utility
In the last section, consumer preferences were
Did You Know??
discussed, where in at a time two consumption
Utility is a concept that was
bundles were compared & ordered (ranked).
Indifferent, strictly preferred and weakly preferred,
introduced by Daniel
all are binary relationships defined over bundles of Bernoulli. He believed that
commodities. It would be easy if we cold assign for the usual person, utility
numeric values to the bundles in such a manner increased with wealth but at
that preserve the ordering of bundles.1 Preserving a decreasing rate.
the order of consumption bundles, refer to
assigning higher value to preferred bundle than
less-preferred bundles.

3.1 Assigning Utility

It is a function mapping of a consumption of a bundle to a unique, real number representing
utility desired from that bundle.

U: (x,y) →

So, utility function is a real valued function

If a bundle (x1,y1) is strictly preferred over (x2,y2) then u (x,1y1)>U(x2,y2)

There are two set of theories/approaches to measure utility.

a) Ordinal Utility
As the name suggests, ordinal is, only order mattes. Utility can be assigned to
different consumption bundles irrespective of the magnitude, as long as the ordering
of preference is maintained for a particular consumer. For ex: A consumer prefers
Bundle 1 to bundle 2 then, Utility assigned to bundle 1 can be 1, 10 or 1000
provided that every time bundle 2 has “7” and bundle 3 has 90 , then it could be
inferred that bundle 3 is most preferred bundle, nest to it is bindle 1 and least
preferred one is bundle 2 . But it cannot be inferred from the above information
that bundle 3 is 9 times better bundle than bundle 1.

b) Cardinal Utility
There are economists who hold that magnitude of utility is of significance. This is the
known as cardinal utility assignment to consumption bundles.

If is above example, it cold be said with precision that utility of bundle 1 is 10 and of
bundle 3 is 90 : then it means consumer like bundle 3 times be drawn if consumer is
ready to pay nine times the price of bundle 2, for bundle 3.

1
Here axiom of transitivity should be followed for consistency of values assigned.

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3.2 Positive Monotonic Transformation

If g is some increasing function (like g(x) =x2 or x2 in x or ex, Then g of utility function
would not after the order of preferences though the magnitude would so, while dealing with
ordinal utility function, a positive monistic transformation would not change the analysis.

If a bundle (x1,y1) is preferred over (x 2,y2) then u(x1,y1)>u(x2,y2), if g is positively

increasing function then g(u(x1,y1) )>g(u(x2,y2) ) where g(u(.) ) is positive monotonic
transformation of u. This monotonic transformation of a utility function represents same
preferences as the original utility function.

Example:

Bundle\Utility First way U1 Second way Positive Negative

U2 monotonic monotonic
transformation transformation
U1*2 U1*(-2)

1 9 3000 18 -18

2 10 4000 20 -20

3 11 5000 22 -22

In column 2, bundles are given utility in two digit column 3 bundle 1-3 are assigned utilities
in thousand but order of preference is bundle 3,2 and 1.U 1 and U2 are ordinal utilities where
preference of order is important. In column 4, positive monotonic transformation of U1
function is computed by doubling U1. This does not alter the order of preferences of bundle
1-3.But a negative monotonic transformation represented in column 5 by (-2 U1), reverse
the order of preference. Least preferred bundle 1 becomes most preferred; as -18 is greater
than -20 and -22.

3.3 Total and marginal utilities-one good case

When more of good is consumed ,total utilities goes on increasing .Ask yourself, would you
prefer two pair of shoes or one ?obviously , your answer would be two. But, when you buy
first shoe its utility is highest became that one is first one in your wardrobe. Another one

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Adam Smith presented classical paradox called ‘ Water-Diamond’. In statement of this
paradox he proposes, that, water which is more valuable but is priced less than diamond.
He could not resolve this paradox.

Later, the marginal-utility theory of value resolved the paradox. Water in total is much
more valuable than diamonds in total because the first few units of water are necessary
for life itself. But, because water is plentiful and diamonds are scarce, the marginal value
of a pound of diamonds exceeds the marginal value of a pound of water. It can be
assumed that for water we are at a point on MU curve at higher quantity and for
diamonds we are still at a point with less of Diamond (i.e. commodity on x-axis) is
consumed.

have some utilities but obviously less than first one and so on .These two argument are
consistent since former is in relation to total utility and latter to marginal utility. Total utility
always increase with increase in number of units consumed. While addition made to this
total utility falls.

Marginal utility=∆U/∆x= U(x2) -U(x1) =MU

x2-x1

If x2>x1, then U(x2)>U(x1), hence marginal utility is positive. Though it falls if x2 increases
to x32 that is MU’ is smaller than MU measure, where MU’ is
given by

MU'=U(x3)-U(x2)

x3-x2

4. Indifference Curve Analysis

There could be various consumption bundles amongst which a consumer is indifferent .For
example two serving of rice with three chapattis could give same satisfaction as three
serving of rice with two chapattis .All such a combination give same fixed level of utility to

2
Please see appendix to this chapter for the calculus treatment of it.

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consumer. Indifference (referring to bundles for which a consumer is indifferent) Curve is

locus of all such consumption bundles which yield same level of satisfaction/utility.
Indifferent curves are also known as Iso-utility curve.

4.1 Well Behaved Indifference Curve:

Let us consider following arbitrary indifferent curve.

Figure1 Assumed Indifference curve

Let us assume that the above curve is locus of all consumption bundles at which consumer
has some constant utility throughout. There are upward sloping and downward sloping
sections3 of our assumed indifferent curve. A positively sloped indifferent curve would mean
that more of both commodities like at point B and less of both commodities like at point C

Figure2 positively sloped indifference curve

3
BC ,DE are upward sloping section and AB,CD, and downward sloping section of indifference curve here.

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both commodities; give same level of utility to consumer. But is it consistent? No, strictly
more of both commodities should add utility for the consumer.4

So, now our indifferent cure would not be upward sloping. We can now have only indifferent
curve which is downward sloping .A downward sloping indifferent curve mean that as we
move along the indifference curve from point C to point D (in figure 3) would mean more of
goods x with less of goods y. So good y is sacrificed so that addition made to utility from
extra consumption of x, is equivalent to loss of utility due to reduction of y. CDE is
negatively sloped 5 but with D as point of inflexion6.

CD section of assumed indifference curve is convex to the origin while DE section is concave
to the origin.

Figure3 negatively sloped indifference curve with point of inflexion

Now, next have to examine whether indifference cure need be convex or concave or could
be both.Let us examine concave section DE, first. In figure 4, on x-axis change in units of x
is assumed to be 1 unit and change in y is due to change in x.

4
Though addition made would be declining (due to diminishing marginal utility), but both add to positive utilities.
Unless either good becomes ‘bad’, this is discussed in sections to come.
5
You can check its slope as negative or downward by drawing tangent at various points.
6
Point of inflexion is a point at a curve from where the curvature of a curve changes.

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Figure4 concave indifference curve

To increase consumption of x by 1 unit, change in y (along DE) goes on increasing. But from
our knowledge of marginal utility, marginal utility of a good is high at lower levels of
consumption and low at higher levels of consumption. So as we move from point 1 to 2 and
further towards E ; loss of marginal utility from reduced y is greater than additional of
marginal utility from increased x. The reason for the same being y is lost at greater pace
than addition made to x .So, indifference curve cannot be concave7.

Indifference curve, so assumed in figure 1 had a thicker section GHI reconstructed here. It
can have bundles 1 and 2 and many such bundles. Here bundle 2 contains more of both
goods compared to bundle 1 and hence have higher utility.8 So, assumption that these
points are on same indifference curve is violated.

Figure5 Thicker section of indifference curve

7
Concave indifference curve can be observed and will be explained in coming sections.
8
This property is known as assumption of monotonicity.

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So, indifference curve sections excluded from our assumed shape of indifference curve are

(1) upward sloping

(2) concave to the origin
(3) Thicker line.

4.2 Properties of indifference curves

4.2.1 Negatively sloped:

Indifference curve is negatively sloped as utility addition due to increase in one good should
be compensated by decrease in other good.

4.2.2 Thinner lines :

Indifference curve should be thin curves as thicker lines would have areas of strict
preference.

4.2.3 Convexity:
Indifference curve must be convex. Convexity would imply that fall in y- accompanied with
increase in x- should get smaller as more of x is added. Look at the following two diagrams
and the explanation that follows.

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Figure6 (a) total utility curve, (b) Indifference curve

At point 1 on Indifference curve I0 ,x1 of x and y1 of y is consumed that yields utility of level
I0. Panel B of figure 6 shows corresponding utility achieved from these consumptions. When
one moves to point A, consumption of y decrease to y 2 and of x increases to x2.This leads to
increase in utility from TU to TU1 so MU1 is added. To compensate, there should be greater
fall in y (more than one unit) since fall in one unit of y decreases utility by MU 3(which is less
than MU1). So, y must fall by two units (since MU3 + MU2 = MU1). Further, if x is added then
TU3 is achieved and change is MU2 but now y must fall by less than a unit since again fall in
utility due to y (MU1) would be greater than rise in utility from x (MU2). A change in y
should be brought such that loss in utility equals MU2.

4.2.4 Indifference curves do not intersect

Indifference curves should not intersect so as to retain axiom of transitivity. Let us consider
that indifference curve intersect as shown in figure7.

Figure7 intersecting indifference curves

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Point C compared to point A yields more of utility as described by monotonicity. A consumer

is indifferent between A and B (being on same indifference curve I0) and also, indifferent
between B and C (being on same indifference curve I1). So by transitivity consumer should
be indifferent between A and C which is not the case. Hence, axiom of transitivity in
violated.

4.3 Well behaved preferences and Indifference curves

The assumption of monotonicity assumes that more of both the goods are better. Hence,
higher the indifference come higher is the utility as is shown in fig. 8. The shaded area in
fig 9, shows weakly preferred set to (x1,y1).

Figure 8 Monotonicity Figure 9 weakly preferred set

The second assumption for well behaved preferences is that averages are preferred to
extremes. Let (x1, y1) & (x2, y2) be on the same indifference curve in fig. 10. Then average
of these two extreme boundless lie above the curve. And, this average would be in a weakly
preferred set iff indifference curve is convex. Consider other (non convex) cases in panel b
& c of fig 10.

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Figure 10

4.4 Satiation point

The level of consumption beyond which utility attached to an extra unit of the good is zero
or negative is known as satiation level or saturation level. Assume two goods, chapatti and
vitamin B tablets. Up to a limit, both are needed and add to utility. Say for individuals 6
chapattis and two tablets are required for healthy living, beyond this level utility falls. Let
us denote such respective levels by x1 in fig. 11( it is done for sake brevity).

Figure11 total utility declines after x1

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Figure 12 satiation point

The arrows in this figure, show chapatti direction of maximal increase.

Highest level of utility is achieved is at ( 6,2) which is known as bliss point ( fig.12)
Indifference curve is downward sloping in quadrant ‘I’ showing that one good has to be
sacrificed to add extra unit of good to keep utility constant

Figure13 both are ‘good’ Figure 14 x is ‘bad’

In ‘II’, Good x (chapatti) becomes ‘bad’ i.e. add to disutility (you can think beyond this he
can have digestive order). But good on y – axis, tablets is yet a ‘good’. Indifference curve
is reproduced again in fig14. The disutility from addition of x is to be compensated by utility
from good y. Indifference curve I2, denotes higher utility than I1 and I0. At I2, y1 level of y
is combined with smaller level of bad x compared to Io, hence I2 shows greater utility.

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Alternatively, with x 2 level of bad x higher level of good y is combined at I2 indifference

curve.

For Scooby and Shaggy facing moster is a bad…. So to keep them at same utility velma needs
to offer Scooby Snax(good).

In ‘III’, good on y – axis becomes ‘bad’ & good x is yet ‘good’. The indifference curves are
reproduced in fig.15.

Figure15 y is ’bad’

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In ‘IV’, both goods become ‘bad’. Indifference curves are negatively sloped but direction of
maximal increase is towards origin & indifference curves are concave to the origin as shown
in fig 16. The indifference curves are circles with satiation point at the centre.

Figure16 both are ‘bad’

4.5 Marginal Rate of substitution

The slope of indifference curve9 is known as marginal rate of substitution. The slope
indicates change in y when x changes by 1 unit. For indifference curve, it would mean that y
is substituted for x in a way that utility is held constant. And, as we saw in earlier sections;
at smaller levels of y, smaller sacrifice would be made as loss in utility from sacrificing 1
unit is high and at greater levels of y, larger sacrifice could be made. Hence, marginal rate
of substitution is diminishing10 along the indifference curve (assuming convexity and
monotonocity). Figure17 shows Δy is declining11 for 1 unit addition in good x.

9
Slope of indifference is different at at different points of indifference curve.Only for a straight line slope is
constant.
10
It is the abosulate number which is reffered here.
11
Also see appendix to this chapter for calculus treatment of it.

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Figure17 diminishing MRS

4.6 Special cases of preferences & their indifference curves

In this section, we would cover various forms of utility functions and analyze marginal rate
of substitution of their respective indifference curves.

4.6.1 Neutral Good

A good is said to be neutral if any quantity of a good can be added & no change in utility is
brought about. Assuming good y is neutral & good x is good then indifference curves are
vertical and utility increases with increase in consumption of x only. Example of such a good
( neutral ) could be that consumer does not care about how many hours T.V runs in his
room but he cares how many books he get to read.

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Figure18 good on y axis is neutral

4.6.2Perfect substitutes
Two goods are substitutes if the consumer is willing to substitute one good for another at a
constant rate. Constant marginal rate of substitution means that indifference curves are
straight lines.

One ‘Ten rupee bank note’ is perfect substitute of two ‘five rupee bank note’. If ten rupee
note is denoted by y & five rupee note by x: then utility U = x + 2y.

Figure19

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The trick to remember that what should be coefficient of x & y is utility function is: since, 1
unit of y gives twice the utility compared to 1 unit of x. Likewise , if ‘a’ units of y gives same
utility as ‘b’ units of x then utility function becomes: U = ax+by and MRS =-a /b

4.6.3 Perfect Compliments

Perfect complements are goods that are consumed together in fixed proportions. Best
example quoted for this is left shoes & right shoes. Bundle (1,1) gives same utility as (2,1)
or (1,2) because extra of either of these would not be useful & hence, no utility is gained.

Figure20 perfect compliments

Indifference curves for perfect complements are hence L–shaped with kink at 45˚ line
(because of 1:1 ratio). Slope at vertical portions is infinity as Δx (denominator) is zero &
slope at horizontal portion is zero as Δy (numerator) is zero. If two teaspoons of sugar is
added to one cup of tea then indifference curves are as in panel A of fig 21. For a general
case, where ‘a’ units of x are consumed with & ‘b’ units of y indifference curves are as
shown in panel B of fig.21.

Figure 21: (a) 2 tps of sugar is taken with 1 cup of tea; (b) ‘a’ units of x is taken with ‘b’ units
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 Preferences And Indifference Curves

The utility function is written as follows:-

U = min{x, y}; if one unit of good y is consumed with 1 unit of x.

U = min {2y,x};for sugar (x) & tea (y) example.

& U = Min { bx, ay}; if ‘a’ units of x are consumed with ‘b’ units of y.

In the form U(x1,x2)=Min.{x,y} utility would be minimum of two levels of consumption of

goods. Consider shoes example:

Utility, U=1=min[1,1] =min[2,1] =min.[1,2]

4.6.4 Cobb Douglas Preferences

Cobb Douglas utility function has convex shaped indifference curves. Utility function takes
the form: U(x,y)=xα yβ .The indifference curves appear like in figure22.

Figure22 Cobb Douglas preferences

Marginal rate of substitution of x for y is given by:

MRS=-MUx/MUy =-axa-1yb/bxayb-1=-ay/bx

4.6.4 Quasi linear preferences

Quasi linear, as the name suggests utility function is linear but in one good and non-liin
other. Let utility function be linear in good y and non-linear in good x. then, utility function:

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U(x,y) = v(x) + y. Here utility is equal to the height of indifference curve along the y-axis
i.e. when x is zero, utility is equal to consumption of y.

Figure23 Quasi linear preferences

The indifference curves are just vertically shifted versions of one indifference curve.

4.6.5 Discrete goods

All the cases considered till now assumed that goods are continuously divisible. There are
many goods like milk, rice, wheat that can be consumed in fraction. But there are goods like
automobiles, smart-phones, TV sets which are discrete in consumption.

Figure24 discrete goods

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The dashed lines connect indifferent bundles (though consumption at other than dots are
not possible). Strong lines show weakly preferred to (x 1,y1)

Summary:
(1)Three axioms of preferences viz. completeness, reflexivity and transitivity are made
about the consistency of consumers’ preferences.

(2)Utility function is a mapping of consumption bundles to their respective real values.

While ranking bundles, order of preferences only matters and this approach is known as
ordinal utility. Positive monotonic transformation of utility function is always consistent with
original ranking of bundles.

(3) Properties of indifference curves are as follows:

(a) Negatively sloped, (b) convex to the origin, (c) curves are thin, (d) indifference curves
do not intersect and (e) higher the indifference curves higher the utility.

(4) Beyond a point /level of consumption of any good, disutility is generated i.e. too much
of a good or negative utility. At this level, utility is maximum and such a point is known as
satiation point.

(5)Well behaved preferences exhibit declining marginal rate of substitution i.e. sacrifice of y
each time when x is increased; keeps on declining.

(6) Indifference curves that are convex (but do not general smooth curve with declining
MRS) are for perfect substitutes, perfect compliments, and quasi-linear preferences and
even for discrete goods.

(6)Goods can be good, bad or neutral. If a good is good then it adds to utility when its
consumption is increased else add to disutility (negative utility) if bad and zero utility if
neutral.

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Exercises
Q1. Sumit has Cobb –Douglas preferences and his utility function is given by U(x,y) =xy.
State true or false about the following statements considering sumit’s preferences:

a) (10,5)~ (5,10)

b) (20,5) ≥ (4,25)

c) (15,4) ≥ (7.5,7.5)

Q2. The marginal rate of substitution for sumit with utility function is U(x,y)=xy; is given
by:

a) x/y

b) y/x

c) x2/y2

d) y2/x2

Q3. Match the utility functions with their MRS at (x,y)=(4,9):

i) x+y a) 1.5

ii) x+√y b) 1

iii) x0.5y0.5 c) 6

Q4. If the utility function is U(x,y) = x2-y2. Then what can you conclude about nature of
these goods:

a) x and y both are good

b) x is good and y is bad

c) x is good nad y is neutral

d) x is bad and y is good

Q5. Which of the following pairs of goods are compliments or substitutes:

a) popular novel and Magazine.

b) A camera and a film.

Q6. a) Consider a utility function U(x,y) = √xy. Calculate its MRS.

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b) Is V(x,y) = x2y2 monotonic transformation of U?

c) Calculate MRS of V(x,y). Is it different from MRS calculated in part (a)?

Q7.If both good x and y are bads, draw and explain consumer’s indifference curves.

Q8. a) Consider a utility function of Vaibhav as U(x,y)= 4√x + y. Vaibhav consumes 9

units of x and 15 units of y. His consumption of x is reduced to 4 units, but is given
sufficient of good y that there is no loss (or no addition to) of utility. How many units of y
does Vaibhav consume?

b) Draw indifference curves showing vaibhav’s preferences.

c) Calculate Vaibhav’s MRS. Is his preferences homothetic?

Q9. Poonam’s utility function is U(x,y) = max{x,y}.

a) Draw her indifference curves.

b) If Poonam consumes(10,20),Calculate her utility at this bundle.

c) State true or false about Poonam’s preferences:

i) (10,20)~(20,10)

ii) (20,10)>(15,15)

d) Is Poonam’s preference convex?

Q10. Consider utility functions:

a) U(x,y)= xy

b) U(x,y)= x2+y

Show that both of these has diminishing marginal rate of substitution.

Glossary
 Indifference curve: A curve showing the locus of combinations of the amounts of
two goods such the consumer is indifferent between any combinations on that curve.

 Marginal rate of substitution: It refers to the amount of one good that is required
to compensate the consumer for giving up an amount of another good such that the
consumer has same level of utility as before.

 Perfect substitutes: Two goods are substitutes if the consumer is willing to

substitute one good for another at a constant rate.

 Perfect compliments: Perfect complements are goods that are consumed together
in fixed proportions.

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 Bad good: A good is said to be bad if addition in its quantity creates disutility even
at lower levels of consumption.

 Neutral good: A good is said to be neutral if any quantity of a good can be added &
no change in utility is brought about.

 Monotonicity: Monotonicity principle is ‘More is better’ and implicitly takes good-

good and leaves bad-giood.

 Well behaved preferences: preferences are well behaved when indifference curves
are negatively sloped and convex to the origin.

Appendix

A.1 Diminishing marginal utility

Given utility function U(x), du/dx is positive stating that ‘good’ adds value to its consumer.
Fall in marginal utility as x increases; refer to the downward slope of marginal utility curve.
This is computed by d2u/dx2. d2u/dx2 should be negative not du/dx to fulfill diminishing
marginal utility. MU in first quadrant assumes all positive values and but its slope is
negative, due to negative relationship between addition made to utility and consumption of
units.

Figure A1 diminishing marginal utility

A.2 Indifference curves are level curves of utility function

We assume two good x & Y on the x & y – axis respectively. Various combinations of these
goods like A and B yields some utility which is represented on Z-axis. Combination is raised
to the height equivalent to utility of bundle A shown by point A'. Similarly; for all such
bundles, utility curve is drawn (as shown in fig. A2).

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 Preferences And Indifference Curves

FigureA2 utility function

At various heights say α, a disc is seen (with point A' on it). Assume, this disc drops down
on x y plane; which then appears like in fig.A3. C' is the Bliss point where utility is
maximum. C' corresponds to point C in xy plane, which is satiation point.

FigureA3 indifference curves as level curves of utility function

A.3 Diminishing Marginal Rate of Substitution

Utility depends on consumption of good x & good y.

U = f (x,y)

Taking total differential of it, we get :

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 Preferences And Indifference Curves

ΔU= Δx+ Δy

ΔU=MUx Δx +MUy Δy

On an indifference curve, there is no change is level of utility. Therefore,

MUx Δx+MUy Δy=0

Or, Δy/Δx=-MUx/MUy

As x increases MUx falls and as y declines MUy increases. Both of which imply that this
fraction falls as x increases. Hence we witness diminishing marginal rate of substitution
along the indifference curve.

References:

Hal R. Varian, Intermediate Microeconomics: A Modern Approach, W.W. Norton and Company/Affiliated
East-West Press (India), 8th edition, 2010.

C. Snyder and W. Nicholson, Fundamentals of Microeconomics, Cengage Learning (India), 2010.

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