Microeconomics Study Notes: Consumer Choice, Indifference Curves, and Production Theory

Consumer Choice and Indifference Curves

Properties of Preferences

Understanding consumer preferences is essential for analyzing choices in microeconomics. Preferences are typically assumed to have the following properties:

• Completeness: For any two bundles A and B, the consumer can state either A is preferred to B, B is preferred to A, or is indifferent between them.

• Transitivity: If A is preferred to B and B is preferred to C, then A is preferred to C.

• Monotonicity: More is better; if bundle A has at least as much of every good as bundle B and more of at least one good, then A is preferred to B.

Types of Goods

Goods are classified based on how demand responds to changes in income:

• Normal Goods: Demand increases as income increases.

• Inferior Goods: Demand decreases as income increases.

• Giffen Goods: A rare type of inferior good where demand increases as price increases, violating the law of demand.

Note: All Giffen goods are inferior, but not all inferior goods are Giffen.

Indifference Curves

Indifference curves represent combinations of goods that provide the consumer with the same level of satisfaction.

• Perfect Substitutes: Goods that can be substituted at a constant rate; indifference curves are straight lines.

• Perfect Complements: Goods that are consumed together in fixed proportions; indifference curves are L-shaped.

• No crossing or thick indifference curves: Indifference curves cannot cross and are always thin lines.

Optimal Consumption Bundle: The point where the budget line is tangent to the highest possible indifference curve.

Budget Line: Represents all combinations of goods that a consumer can afford given their income and prices.

Production Theory

Marginal Product and Marginal Rate of Technical Substitution (MRTS)

Production theory examines how firms transform inputs into outputs. Key concepts include:

• Marginal Product of Labor (MPL): The additional output produced by one more unit of labor.

• Marginal Product of Capital (MPK): The additional output produced by one more unit of capital.

• MRTS: The rate at which a firm can substitute labor for capital, keeping output constant.

Formula for MRTS:

• $MRTS = -\frac{dK}{dL} = \frac{MPL}{MPK}$

Interpretation: MRTS is the absolute value of the slope of the isoquant (curve showing all combinations of inputs that yield the same output).

Production Functions

Production functions describe the relationship between inputs and output. A common example is the Cobb-Douglas production function:

• $Q = A L^\alpha K^\beta$

Where Q is output, L is labor, K is capital, and A, α, β are parameters.

• Increasing Returns to Scale: If doubling inputs more than doubles output (α + β > 1).

• Decreasing Returns to Scale: If doubling inputs less than doubles output (α + β < 1).

Cost Functions

Cost functions relate the cost of production to the quantity produced:

• $C = wL + rK$

Where C is total cost, w is the wage rate, L is labor, r is the rental rate of capital, and K is capital.

Optimality Condition for Production

Firms choose input combinations to minimize cost for a given output. The optimality condition is:

• $MRTS = \frac{w}{r}$

This means the rate at which the firm can trade labor for capital equals the ratio of their prices.

Labor and Capital as Complements

Increasing capital can make labor more productive, and vice versa. This is especially true when inputs are complements in production.

• Example: Adding machinery (capital) increases the productivity of workers (labor).

Summary Table: Types of Goods

Type of Good	Income Effect	Price Effect	Example
Normal Good	Demand increases as income increases	Demand decreases as price increases	Organic food, electronics
Inferior Good	Demand decreases as income increases	Demand decreases as price increases	Instant noodles, bus rides
Giffen Good	Demand decreases as income increases	Demand increases as price increases	Staple foods in extreme poverty (rare)

Additional info:

• Some content was inferred from context and standard microeconomics curriculum, such as the Cobb-Douglas function and the optimality condition for production.

• Equations and definitions were expanded for clarity and completeness.