Microeconomics: Indifference Curve, Marginal Rate of Substitution, Budget Constraint, Diminishing Marginal Utility, Income and Substitution Effects, Behavioral Economics

Running head: ECONOMICS
Economics
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Table of Contents
Question 1........................................................................................................................................2
a) Consumer Indifference Curve.................................................................................................2
b) Marginal Rate of Substitution.................................................................................................3
c) Consumer Budget Constraint...................................................................................................4
d) Diminishing Marginal Utility..................................................................................................5
e) Income and Substitution Effects..............................................................................................6
Question 2........................................................................................................................................6
Behavioral economics..................................................................................................................6
Reasons behind irrational behaviors of consumers.....................................................................7
References......................................................................................................................................10

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Question 1
a) Consumer Indifference Curve
Indifference curve is an important microeconomics concept used for studying behavior of
consumers. An indifference curve represents a graph showing different combination of two
goods that give consumers equal level of utility and satisfaction. This is a heuristic tool used in
the contemporary economics that is used to illustrate preferences of consumers and limitation in
consumer budget (Kreps 2019). Recently, the principles of indifference curves is used in welfare
economics.
A standard indifference curve is plotted on a two dimensional framework. Each axis
measures one type of good. Along the curve each combination of two goods ensures same level
satisfaction to the consumer.
Figure 1: Indifference curve
There are some basic assumption behind the theory of indifference curve. These are as
follows

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 Two commodities
 Non-Satiety
 Ordinal utility
 Diminishing marginal rate of substitution
 Rationality of consumers
Indifference curve drawn on the basis of above mentioned assumption has the following
properties
 Indifference curve slopes downward to right
 Indifference curve convex to the origin
 No two indifference curve can intersect each other (Cowell 2018).
 Higher indifference curve shows higher level of satisfaction
b) Marginal Rate of Substitution
In microeconomics analysis, marginal rate of substitution indicates amount of a good that
a consumer is willing to sacrifice to consume one additional unit of another good, given the good
gives equal level of satisfaction to the consumer. The concept is mainly used in the theory of
indifference curve analysis. MRS is computed between the two goods shown on the indifference
showing frontier of equal utility of each combination of two goods. The formula for marginal
rate of substitution is given as
MRSX ,Y = MU X
MU Y