Indifference curves and revealed preference theories are useful concepts for MBA students who want to make proper decisions in the real world. This post is written with the intention of providing MBA students with a comprehensive explanation of the principles of indifference curves and their role in revealed preference theory. A step-by-step calculation on how to construct indifference curves with the help of stata coding has been illustrated as a practical example. Also, this post covers some tips and benefits of engaging with managerial economics homework help experts who can guide you with the correct approach of solving complex questions related to indifference curves and its calculation using stata software.
An indifference curve is a graph that illustrates the various combinations of products that offer a consumer equally high levels of utility or satisfaction. Changes in a combination are perceived as irrelevant by the consumer if it is situated on the curve. The consumer has no preference for one combination over another on the same curve, as each point on the curve represents the same level of utility.
Knowledge about the slope of an indifference curve plays an essential role in explaining how a consumer is ready to swap one good for another while keeping the level of satisfaction in mind.
The indifference curve analysis help in understanding how consumers allocate their money due to budget constraints. They have a crucial part to play in how consumers responded in regards to changes in prices.
Prominent economist Paul Samuelson developed the Revealed Preference Theory that provides clear real-life application when analysing consumer choices. While the neoclassical theory presupposes the utility maximisation based on an abstract utility function. This theory analyses the consumption choices that consumers make based on definite constraints of a budget. When a consumer decides between two baskets of goods each of them being affordable, it suggests that the choice provides at least as much satisfaction as the other choice.
It works under the assumption that, decision voluntarily made represents the real preferences. For instance, if over a period spanning several times the consumer is always choosing between bundle A and bundle B, one is likely to conclude that the consumer holds a preference for bundle A. It is through this insight that economists and business people are be able to know the priority of the consumers. From these revealed preferences, it will be possible for businesses to bring forth products and marketing techniques that will in a way serve the market better, while on the other hand policymakers will be able to formulate more efficient economic policies that can be in line with the actual behaviour of the consumer.
Indifference curves are very useful in Revealed Preference Theory because they show preferences and insights on utility of consumers. Indifference curves that depict varieties of goods in which a consumer is equally satisfied to switch or ‘combinations of goods between which the consumer is indifferent’. In Revealed Preference Theory, if the consumer opts for a particular bundle of goods instead of a another, then it means the former is on the higher Indifference curve, giving out their preference.
Example: Consider two goods, X and Y. A consumer’s choice between these goods can be represented on a graph with indifference curves. If a consumer chooses bundle (X1, Y1) over bundle (X2, Y2) given their budget constraint, the indifference curve passing through (X1, Y1) lies above the curve passing through (X2, Y2), indicating a higher utility level for the chosen bundle.
Consider a simple utility function of the form U (X, Y) = X⋅Y, where X and Y are two goods. This utility function assumes that the consumer’s satisfaction (utility) increases with the quantity of both goods and that the two goods are perfect complements in consumption. To construct indifference curves, we need to select specific utility levels. Let’s choose three different utility levels for this example:
U1 = 10
U2 = 20
U3 = 30
For each chosen utility level, we solve for Y in terms of X to plot the indifference curves. Given the utility function U (X, Y) = X⋅Y, we rearrange it as: Y=U/X ? Substituting the chosen utility levels:
For U1 = 10: Y = 10/X
For U2 = 20: Y = 20/X
For U3 = 30: Y = 30/X
We will plot these equations on a graph to visualize the indifference curves. Each curve represents a different level of utility and shows the trade-offs between goods X and Y that provide the same level of satisfaction to the consumer.
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STATA Code: clear set obs 100 // Set the number of observations gen X = _n // Generate a sequence for X from 1 to 100 // Define utility levels gen U1 = 10 gen U2 = 20 gen U3 = 30 // Calculate Y values for each utility level gen Y1 = U1 / X gen Y2 = U2 / X gen Y3 = U3 / X // Plotting the indifference curves twoway (line Y1 X, lcolor(blue) lpattern(solid) lwidth(medium)) /// (line Y2 X, lcolor(red) lpattern(dash) lwidth(medium)) /// (line Y3 X, lcolor(green) lpattern(dot) lwidth(medium)), /// title(“Indifference Curves for Different Utility Levels”) /// xlabel(0(10)100) ylabel(0(1)30) /// legend(label(1 “U = 10”) label(2 “U = 20”) label(3 “U = 30”)) |
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