The ability to predict with some accuracy the response of consumers to this policy is vital to determining the merits of the policy before millions of federal dollars are spent. The table given below is an example of indifference schedule and the graph that follows is the illustration of that schedule. Marginal utility refers to the utility gained from the consumption of an additional unit of a good or service.
We have assumed our consumer a rational consumer he always aims at getting the maximum satisfaction (utility) out of his income taking the prices and other relevant information into account. In the above image, the combination outside the budget line (S) represents the one beyond the income. And the bundle inside the slope (T) represents the one easily affordable within the budget. If a consumer purchases two goods, the budget limitation can be displayed with the help of a budget line on a graph. A budget line reveals all the possibilities in combinations of two goods a consumer can purchase with limited income. It allows the consumer to buy within a given budget, i.e., within their current income.
This property is based on the law of diminishing marginal rate of substitution. If indifference is not convex to the point of origin 0, it can either be a straight line or concave. But it can be proved with the help of the diagram that on the basis of the assumption of the law of diminishing marginal rate of substitution both these situations are not possible. In the diagram quantity of apples is shown on the ox-axis and the quantity of oranges on the oy-axis. Combination A on this curve represents more units of oranges with the same units of apples as compared with combination C. The highest achievable indifference curve touches the budget constraint at a single point of tangency.
- As seen in the schedule, consumer is indifferent between five combinations of apple and banana.
- He is equally satisfied with OF units of rice and OK units of beans shown by point b on the indifference curve.
- It is possible when a consumer is willing to sacrifice some quantity of a good to gain an additional unit of another good.
- From this example, we can see that indifference curves for perfect complements have right angles.
Diminishing marginal rate of substitution:
It means the consumer has in his possession OM quantity of money and does not want any unit of apples. At a point, N consumer likes to have a combination of OQ units of apples and OP units of money. This combination will yield him the same satisfaction as by what are the properties of indifference curve keeping OM units of money. The money income or budget of each consumer is given which is spent on purchasing various goods and services to satisfy his wants.
Properties of Indifference Curve with Diagram and Examples
The curve slopes downward as the consumption of commodity A increases in exchange for commodity B. It, thus, maintains the same level of consumer satisfaction in all combinations. A higher indifference curve shows a higher level of satisfaction. Hence, a consumer prefers to reach the tallest line to attain a higher utility level.
Because in the case of combination A if the quantity of oranges is more than in combination B, then the quantity of apples is less than in combination B. Consequently, the slope of the indifference curve will be downward sloping. Indifference curves slope downward to the right because the consumer has to reduce the consumption of one commodity (y) if he increases the consumption of commodity-x. In order to maintain the same level of satisfaction, he has to increase the consumption of commodity x with the decrease in the consumption of commodity y. A consumer that conforms to the “well-behaved” conditions of consumer preferences, and thus the indifference curve for this consumer’s choice problem behaves as expected.
All Combinations on an Indifference Curve gives Same Level of Satisfaction
Different values of c correspond to different indifference curves so we obtain a new curve that’s plotted above and to the right of the previous one if we increase our expected utility. IC is based on an assumption that a consumer is fully aware of his/her preference for various commodities. However, this is an unrealistic assumption as humans have their limitations.
- In the graph below, there are three different indifference curves, labeled A, B, and C.
- Human decision-making, driven by our preferences, is at the core of economic theory.
- Consumer’s preference of 1st bundle as compared to 2nd bundle will be called monotonic preference as 1st bundle contains more of apples, although bananas are same.
- We can see that when X1 amount of commodity X was consumed, Y1 amount of commodity Y was also consumed.
- An indifference curve is defined as a curve that gives an equal level of satisfaction to a consumer at every possible combination.
- Thus, The figure shows that with every fall in the price of grapes, The budget line shifts to the right.
Indifference Curve Analysis: Concept, Assumption and Properties
An indifference curve is a locus of all combinations of two goods which yield the same level of satisfaction (utility) to the consumers. Hicks and Allen criticized Marshallian cardinal approach of utility and developed indifference curve theory of consumer’s demand. This can be explained by considering a hypothetical situation where two indifference curves intersect. On the indifference curve (IC), there can be several other points in between the points a, b, c, d, and e, which would yield the same level of satisfaction to the consumer.
A graph of all the combinations of bundles that a consumer prefers equally. Similarly, points A and C on IC2 also give the same level of satisfaction. It means, points B and C should also give the same level of satisfaction. However, this is not possible, as B and C lie on two different indifference curves, IC1 and IC2 respectively and represent different levels of satisfaction. Therefore, two indifference curves cannot intersect each other. Higher the indifference curves, higher will be the level of satisfaction.
As you go down the curve of an indifference curve, the curve becomes flatter as one good is substituted for the other. The consumer ranks his preference according to the satisfaction of each combination. He does not know actually his satisfaction but he always expresses his preferences for the various bundles of commodities. Hence ordinal utility measurement is necessary and not cardinal measurement. When these combinations are plotted on the graph, the resulting curve is called indifference curve.
More generally, for any point on a lower indifference curve, like Ul, you can identify a point on a higher indifference curve like Um or Uh that has a higher consumption of both goods. Lilly would receive equal utility from all combinations of books and doughnuts on a given indifference curve. Any points on the highest indifference curve Uh, like F, provide greater utility than any points like A, B, C, and D on the middle indifference curve Um. Similarly, any points on the middle indifference curve Um provide greater utility than any points on the lowest indifference curve Ul. We can apply the principle of preferences and the assumptions we make about them to this particular question by drawing indifference curves, as shown in figure 1.9. As two indifference curves cannot represent the same level of satisfaction, they cannot intersect each other.
Similarly, to move from Combinations B to C, C to D, and D to E, she has to sacrifice 4, 2, and 1 unit of ice-creams, respectively, for the consumption of one extra unit of chocolate at each movement. This sacrifice of units of a good to gain an additional unit of another good is known as the . At point C, the consumer purchases only OC of beans and no rice. Similarly, at point E, he buys the OE quantity of rice and no beans. Note also that one of the ordinality analyses is that consumers have a minimum of two commodities hence opportunity for choice exists.
In case an indifference curve touches either axis it means that the consumer wants only one commodity and his demand for the second commodity is zero. An indifference curve may touch the oy-axis if it represents money instead of a commodity. If the indifference curve is upward sloping like IJ, the consumer will get more satisfaction from combination A than B and C. If the indifference curve is downward sloping, the consumer will get equal Satisfaction from A as well as B combinations. As defined then indifference curve gives the same level of satisfaction at different points or combinations of two commodities.
As in the case of Nisha (example above), to gain one more unit of chocolate, she is willing to sacrifice more units of ice-creams. This diminishing marginal rate of substitution gives a convex shape to an indifference curve. The ordinal utility theory or the indifference curve analysis is based on the assumptions as discussed above. Other names for the indifference curve are the Iso-utility curve; Equal utility curve. The different combinations of two goods on the scale of preferences would get the consumer equal satisfaction. If the indifference curve is convex to the point of origin 0, it signifies that the marginal rate of substitution of apples for oranges is diminishing.
Therefore, indifference curves are convex to the origin (see Fig. 2.6). It must be noted that MRS indicates the slope of indifference curve. Indifference Map refers to the family of indifference curves that represent consumer preferences over all the bundles of the two goods.
As we already learned above, consumers always prefer larger quantities. Therefore both curves can’t provide the same level of satisfaction, which means they can never intersect. When more than one curve is represented on a graph showing a different combinations of two different goods on each curve, it is known as an Indifference Map. Each indifference curve on that graph shows one satisfaction level all along the curve.
It means, only one indifference curve will pass through a given point on an indifference map. 2.7, satisfaction from point A and from B on IC1 will be the same. MRS refers to the rate at which the commodities can be substituted with each other, so that total satisfaction of the consumer remains the same. Indifference curve analysis is a purely technological model which cannot be used to model consumer behaviour.
