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Indifference Curve Analysis

Indifference curve analysis was originated in 1881 and refined in 1906 and 1934. It analyzes combinations of two goods that provide equal satisfaction to a consumer. Key assumptions include rationality, ordinal utility, non-satiety, transitivity of choice, and consistency of choice. Indifference curves are always convex to the origin, do not intersect, and higher curves indicate higher satisfaction. Consumer equilibrium is reached where the budget line is tangent to the highest attainable indifference curve.

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Nikunj Mohta
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32 views14 pages

Indifference Curve Analysis

Indifference curve analysis was originated in 1881 and refined in 1906 and 1934. It analyzes combinations of two goods that provide equal satisfaction to a consumer. Key assumptions include rationality, ordinal utility, non-satiety, transitivity of choice, and consistency of choice. Indifference curves are always convex to the origin, do not intersect, and higher curves indicate higher satisfaction. Consumer equilibrium is reached where the budget line is tangent to the highest attainable indifference curve.

Uploaded by

Nikunj Mohta
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Indifference Curve Analysis

Originated by Edgeworth in1881 and Refined by Pareto 1906

Further the Application of IC analysis was proposed by J.R.


Hicks and R.G.D. Allen in 1934

Definition of Indifference Analysis


It is the locus of combination of two goods or commodities,
which yields equal level of satisfaction
Assumptions to Indifference Curve Analysis
❖ Rationality of Consume
The Consumer is Rational & aims at maximizing his Total Satisfaction.
❖ Ordinal Utility
Utility can be expressed Ordinally i.e. Consumer is able to tell only
Order of his Preferences.
❖ Non-satiety
Consumer is not Oversupplied with goods in Questions
❖ Transitivity of Choice
Means that if a Consumer prefers A to B & B to C, he must prefer A to
C. Moreover, A>B then B ≯ A
❖ Consistency of Choice
Means that if a Consumer prefers A to B in one period, he will not
prefer B to A in another period or Treat them as Equal.
❖ Diminishing Marginal Rate of Substitution
Properties of Indifference Curve
Indifference Curves are always Convex to the Origin.
Two Indifference Curves never Intersect or become
Tangent to Each other.
Higher Indifference Curve represents Higher Satisfaction.
An Indifference Curve has a Negative Slope i.e. it Slopes
Downwards.
Marginal Rate of Substitution
(MRS)
• The Rate at which an Individual must give up “Good
A” in order to obtain One More Unit of “Good B”, while
keeping their Overall Utility (Satisfaction) Constant.
The MRS is Calculated between Two Goods placed on an
Indifference Curve, which displays a Frontier of Equal
Utility for Each Combination of “Good A” and “Good
B”.

• MRS Keeps on Declining since Consumer has more &


more units of one Good, he gives up Less Units of
Other Good.
31
10 Price Line or Budget Line

• The BudgetLine shows allthose


Combinations of Two Goods which
the Consumer can buy Spending his
Given Money Income on two Goods
at their given Prices.
•Remember, that the Amount of a Good
that a Person can buy will depend upon
their Income and the Price of the Good.
Price Line or Budget Line
Y
• Point outside the
M PRICE LINE given Price Line,
like H, will be Beyond
Good Y

•H the Reach of
the Consumer.
•K • Point Below the
given Price Line,
O X
N
Good X Like K, shows the
Under Spending of
the Consumer. 40
Consumer Equilibrium

• Consumer Equilibrium will be reached


when he is deriving Maximum possible
Satisfaction from the Goods & is in no
Position to Rearrange his Purchase of Goods.
• The Indifference Map in Combination with the
Budget Line allows us to Determine the
One Combination of Goods and Services
that the Consumer most wants and is able to
Purchase. This is the Consumer Equilibrium.41
Consumer Equilibrium
Y • PL – Budget
P • Line
Points R, S, Q, T,
Good Y
R H all lie on
S
Budget Line.
• But Q is
N Q
IC4
Equilibrium Point.
T IC
IC2 3
H IC1
X
O M L

Good X
42
14 Consumer Equilibrium
• At the Tangency Point Q, the slopes of the
Price Line PL And Indifference Curve IC3 are
equal.
• Slope of Indifference Curve shows MRS of X for
Y (MRSxy)
• At Equilibrium Point Q,

MRSXY = MUX =
PX
MUY PY

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