Deriving Demand
(This section is takes one a bit beyond where one needs
to go in introductory economics, but it illustrates how
indifference curves are used.)
To show what the consumer should do to maximize utility,
a budget line must be added to the preferences shown in the
indifference curves. The picture below adds one. Point
a is not attainable because it lies to the right of
the budget line. The consumer is indifferent between points
b and d because they lie on the same
indifference curve, but point d is cheaper than
b because d lies below the budget line. The
consumer wants to get on the highest indifference curve
affordable, and this will lead him to point c.
The effect of a rise in the price of good A is
shown on the graph below. A higher price of A means
that less of A can be purchased, and hence the budget
line moves to the left, intersecting the vertical axis at a
lower point. Point c is no longer possible and the
consumer must move to a new position, which, assuming
utility maximization, will be point b. Unless the
indifference curves are peculiar, point b will
represent less of good A than will point c, which is
what the law of demand says will happen.
Looking at two different prices has produced two
different points on an individual's demand curve. By varying
the price of good A, other points could be found and
an entire demand curve for one individual consumer
constructed. The market
demand curve is obtained by adding up the demand curves
of all individuals.
The theory of consumer choice that the indifference
curves embody is an elegant construction with which
economists frame problems. One of its weaknesses is that a
great many outcomes are consistent with it--though a
downward-sloping demand curve can be derived from it, so too
can an upward sloping demand curve. Further, in recent years
there has been a realization among economists that pictures
such as those above may not be a good description of the
decision-making process when people must make decisions with
partial information, with fuzzy goals, under conditions of
risk and uncertainty, and when options are difficult to
compare. Finally, there do seem to be cases in which people
systematically violate the
rules that this theory says are rational.
Copyright
Robert Schenk
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