Indifference Curves

 

Meaning

INDIFFERENCE CURVE ANALYSIS

In the last section we discussed marginal utility analysis of demand. A very popular alternative and more realistic method of explaining consumer’s demand is the Indifference Curve Analysis. This approach to consumer behaviour is based on consumer preferences. It believes that human satisfaction being a psychological phenomenon cannot be measured quantitatively in monetary terms as was attempted in Marshall’s utility analysis. In this approach it is felt that it is much easier and scientifically more sound to order preferences than to measure them in terms of money.

The consumer preference approach, is, therefore an ordinal concept based on ordering of preferences compared with Marshall’s approach of cardinality.

Assumptions Underlying Indifference Curve Approach

1. The consumer is rational and possesses full information about all the relevant aspects of economic environment in which he lives.

2. The consumer is capable of ranking all conceivable combinations of goods according to the satisfaction they yield. Thus if he is given various combinations say A, B, C, D, E he can rank them as first preference, second preference and so on.

3. If a consumer happens to prefer A to B, he can not tell quantitatively how much he prefers A to B.

4. If the consumer prefers combination A to B, and B to C, then he must prefer combination A to C. In other words, he has consistent consumption pattern behaviour.

5. If combination A has more commodities than combination B, then A must be preferred to B.

 

What are Indifference Curves? Ordinal analysis of demand (here we will discuss the one given by Hicks and Allen) is based on indifference curves. An indifference curve is a curve which represents all those combinations of goods which give same  satisfaction to the consumer. Since all the combinations on an indifference curve give equal satisfaction to the consumer, the consumer is indifferent among them. In other words, since all the combinations provide same level of satisfaction the consumer prefers them equally and does not mind which combination he gets.

To understand indifference curves let us consider the example of a consumer who has one unit of food and 12 units of clothing. Now we ask the consumer how many units of clothing he is prepared to give up to get an additional unit of food, so that his level of satisfaction does not change. Suppose the consumer says that he is ready to give up 6 units of clothing to get an additional unit of food. We will have then two combinations of food and clothing giving equal satisfaction to consumer: Combination A has 1 unit of  food and 12 units of clothing, combination B has 2 units of food and 6 units of clothing.

Similarly, by asking the consumer further how much of clothing he will be prepared to forgo for successive increments in his stock of food so that his level of satisfaction remains unaltered, we get various combinations as given below:

 

Table Indifference Schedule

 

Combination Food Clothing MRS
A 1 12 6
B 2 6 6
C 3 4 2
D 4 3 1

 Now if we draw the above schedule we will get the following figure. In Figure , an indifference curve IC is drawn by plotting the various combinations of the indifference schedule. The quantity of food is measured on the X axis and the quantity of clothing on the Y axis. As in indifference schedule, combinations lying on an indifference curve will give the consumer same level of satisfaction.

 

Indifference Map: A set of indifference curves is called indifference map. An indifference map depicts complete picture of consumer’s tastes and preferences. In Figure , an indifference map of a consumer is shown which consists of three indifference curves. We have taken good X on X-axis and good Y on Y-axis. It should be noted that while the consumer is indifferent among the combinations lying on the same indifference curve, he certainly prefers the combinations on the higher indifference curve to the combinations lying on a lower indifference curve because a higher indifference curve signifies a higher level of .satisfaction. Thus while all combinations of IC, give same satisfaction, all combinations lying on IC2 give greater satisfaction than those lying on IC1

 

Properties

Properties of Indifference Curves: The following are the main characteristics or properties of indifference curves :

(i) Indifference curves slope downward to the right: This property implies that when the amount of one good in combination is increased, the amount of the other good is reduced. This is essential if the level of satisfaction is to remain the same on an indifference curve.

(ii) Indifference curves are always convex to the origin: It has been observed that as more and more of one commodity (X) is substituted for another (Y), the consumer is willing to part with less and less of the commodity being substituted (i.e. Y). This is called diminishing marginal rate of substitution. Thus in our example of food and clothing, as a consumer has more and more units of food, he is prepared to forego less and less units of clothing. This happens mainly because want for a particular good is satiable and as a person has more and more of a good, his intensity of want for that good goes on diminishing. This diminishing marginal rate of substitution gives convex shape to the indifference curves. However, there are two extreme situations. When two goods are perfect substitutes of each other, the indifference curve is a straight line on which MRS is constant. And when two goods are perfect complementary goods (e.g. gasoline and water in a car), the indifference curve will consist of two straight line with a right angle bent which is convex to the origin or in other words, it will be L shaped.

 

(iii) Indifference curves can never intersect each other: No two indifference curves will intersect each other although it is not necessary that they are parallel to each other. In case of intersection the relationship becomes logically absurd because it would show that higher and lower levels are equal which is not possible. This property will be clear from the following Figure.

indiffernce curve ngp bcca 1st year

 

In figure  IC1, and IC2 intersect at A. Since A and B lie on IC1, they give same satisfaction to the consumer. Similarly since A and C lie on IC2, they give same satisfaction to the consumer. This implies that combination B and C are equal in terms of satisfaction. But a glance will show that this is an absurd conclusion because certainly combination C is better than combination B because it contains more units of commodities X and Y. Thus we see that no two indifference curves can touch or cut each other.

(iv) A higher indifference curve represents a higher level of satisfaction than the

lower indifference curve: This is because combinations lying on a higher indifference curve contain mere of either one or both goods and more goods are preferred to less of them.

Budget line : A higher indifference curve shows a higher level of satisfaction than a lower one. Therefore, a consumer in his attempt to maximise satisfaction will try to reach the highest possible indifference curve. But in his pursuit of buying more and more goods and thus obtaining more and more satisfaction he has to work under two constraints : firstly, he has to pay the prices for the goods and, secondly, he has a limited money income with which to purchase the goods.

These constraints are explained by budget line or price line. In simple words a budget line shows all those combinations of two goods which the consumer can buy spending his given money income on the two goods at their given prices. All those combinations which are within the reach of the consumer (assuming that he spends all his money income) will lie on the budget line

price line ngp bcca 1st year

It should be noted that any point outside the given price line, like H, will be beyond the reach of the consumer and any combination lying within the line, like K, shows under spending by the consumer.

 

 

 

 

 

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