2. OBJECTIVE :-
1. Introduction of Indifference Curve
2. Definition of Indifference Curve
3. Assumptions
4. Constructing an indifference curve
5. Indifference Schedule
6. Indifference Map
7. Marginal Rate Of Substitution (MRS)
8. Budget line
9. Properties of IC
10.Equilibrium
3. INDIFFERENCE CURVES
The technique of indifference curves was
originated by Francis Y. Edgeworth in England in
1881. It was then refined by Vilfredo Pareto, an
Italian economist in 1906. This technique attained
perfection and systematic application in demand
analysis at the hands of Prof. John Richard Hicks
and R.G.D. Allen in 1934.
Hicks discarded the Marshallian assumption of
cardinal measurement of utility and suggested
ordinal measurement which implies comparison
and ranking without quantification of the
magnitude of satisfaction enjoyed by the
consumer .
4. DEFINITION
• An Indifference curve (IC) is the locus of all those
combination of two goods which give the same level of
satisfaction to the consumer so that an individual is
indifferent..
In other words, consumer gives equal
preference to all such combinations.
5. ASSUMPTIONS:
Rational behavior of the consumer
Utility is ordinal
Diminishing marginal rate of substitution
Consistency in choice
Transitivity in choice making
Goods consumed are substitutable
• Transitivity
– if A is preferred to B, and B is preferred to C, then A is preferred to C
– assumes that the individual’s choices are internally consistent
Continuity
if A is preferred to B, then situations suitably “close to” A must also be
preferred to B
used to analyze individuals’ responses to relatively small changes in
income and prices
6. CONSTRUCTING AN INDIFFERENCE
CURVE
Indifference schedule is a list of
various combinations of commodities
which are equally satisfactory to the
consumer concerned.
Combination Apples Oranges
A 1 22
B 2 14
C 3 10
D 4 8
E 5 7
INDIFFERENCE SCHEDULE
8. Utility and Indifference Curves
0
10
20
30
40
50
60
70
80
0 5 10 15
M
usicCD
s
Live
Con
certs
AI
N
D
IF
F
E
R
E
N
C
ES
C
H
E
D
U
L
E
L
v
.C
o
n
c M
s
c
.C
D
s
1
0 2
9 3
8 5
7 8
6 1
2
5 1
8
4 2
6
3 3
6
2 5
0
1 7
0
U1 U2
U3
U4
9. INDIFFERENCE MAP :
A GRAPH SHOWING A WHOLE SET OF INDIFFERENCE
CURVES IS CALLED AN INDIFFERENCE MAP.
0
5
10
15
20
25
0 1 2 3 4 5
Mangoes
Apples
IC1
IC2
IC3
10. MARGINAL RATE OF SUBSTITUTION (MRS)
The marginal rate of substitution of X for Y (MRSxy) is defined
as the amount of Y, the consumer is just willing to give up to
get one more unit of X and maintain the same level of
satisfaction.
MRSxy = Decrease in the Consumption of Y
Increase in the Consumption of X
= (-) ∆Y
∆X
DIMINISHING MARGINAL RATE OF SUBSTITUTION
Combination Apples Oranges MRS
A 1 22 ---
B 2 14 8:1
C 3 10 4:1
D 4 8 2:1
E 5 7 1:1
As the consumer increases the consumption of apples, then for getting every
additional unit of apples, he will give up less and less of oranges, that is, 8:1,
4:1, 2:1, 1:1 respectively This is the Law of Diminishing MRS.
11. LAW OF DIMINISHING MRS
MRS is measured
by the slope of
the indifference
curve
MRS = -O/A = 8:1
12
10
8
6
4
2
0
1 2 3 4 5
A
24
22
20
18
16
14
Apples
Oranges
IC1
MRS = 2:1
MRS = 4:1
MRS = 1:1
12. • MRS changes as x and y change
– reflects the individual’s willingness to trade y
for x
Quantity of x
Quantity of y
x1
y1
y2
x2
U1
At (x1, y1), the indifference curve is steeper.
The person would be willing to give up more
y to gain additional units of x
At (x2, y2), the indifference curve
is flatter. The person would be
willing to give up less y to gain
additional units of x
13. PROPERTIES OF INDIFFERENCE
CURVES
• Higher indifference curves are preferred to
lower ones.
• Indifference curves are downward sloping.
• Indifference curves do not cross.
• Indifference curves are bowed inward or
convex to the origin.
• Indifference curve touches neither X-axis nor
Y-axis.
• Indifference curves are not necessarily parallel
to each other.
• In reality indifference curves are like bangles.
14. 1: HIGHER INDIFFERENCE CURVES
ARE PREFERRED TO LOWER ONES.
• Consumers usually prefer more of
something to less of it.
• Higher indifference curves represent larger
quantities of goods than do lower
indifference curves.
More is preferred to Less
Indifference map
15. 2: INDIFFERENCE CURVES ARE
DOWNWARD SLOPING.
• A consumer is willing to give up one good
only if he or she gets more of the other good
in order to remain equally happy.
• If the quantity of one good is reduced, the
quantity of the other good must increase.
• For this reason, most indifference curves
slope downward.
16. 3:INDIFFERENCE CURVES DO NOT
INTERSECT.
Quantityof Pizza
Quantity
of Pepsi
0
C
A
B
Because each indifference curve represents a specific level of satisfaction. If two
indifference curves intersect each other, then at the point of intersection, the consumer is
experiencing two different levels of utility.
17. 1
MRS = 1
8
3
Indifference
curve
A
4: INDIFFERENCE CURVES ARE
BOWED INWARD OR CONVEX TO
THE ORIGIN.
Quantity
of Pizza
Quantity
of Pepsi
0
14
2
3
7
B
1
MRS = 6
4
6
People are more willing to
trade away goods that they
have in abundance and less
willing to trade away goods of
which they have little.
18. PERFECT SUBSTITUTES
X goods
0
Y goods
2
1
4
2
I1
I2
6
3
I3
a straight-line indifference curve of perfect substitutes, marginal
rate of substitution of one good for another remains constant
20. 5. Indifference curve touches neither X-
axis nor Y-axis.
in Figure I1 if it touches X-axis, at M, the consumer will be having OM quantity
of good X and none of Y. Similarly, if an in difference curve I2touches the У-
axis at L the consumer will have only OL of Y good and no amount of X. Such
curves are in contradiction to the assumption that the consumer buys two goods
in combinations.
21. 6. Indifference curves are not
necessarily parallel to each other
The diminishing marginal rate of substitution between the two
goods is essentially not the same in the case of all indifference
schedules. The two curves I1and I2 shown in figure 11 are not
parallel to each other
22. 7. In reality indifference curves are like
bangles
If he increases his consumption of X so as to reach the dotted portion of the
I1 curve horizontally from point S to N he gets negative utility. If to compensate
himself for this loss of utility, he increases the consumption of Y, he may be
again on the dotted portion of the curve, vertically from point S to M. Thus the
consumer may be on the concave portion of the circular curve. Since by moving
to the dotted portion he gets negative utility, the effective region of the circular
curve will be the convex portion.
23. BUDGET LINE
A line showing all combinations of the
quantities of two goods a consumer can buy
with a given amount of income (budget).
Assuming a consumer is spending all her
income on two (symbolic) consumer goods:
CDs and live concerts,
Income = Pc . Qc + PL . QL
Pc = 15 , PL = 120 , Income = 1200
CD intercept = 80 LC intercept = 10
25. CONSUMER EQUILIBRIUM
It refers to a situation in which a consumer with given
income and given prices purchases such a combination
of goods which gives him maximum satisfaction and he
is not willing to make any change in it.
Assumptions:
1) The consumer has a given indifference map exhibiting
his scale of preferences for various combinations of two
goods, X and Y.
2) Fixed amount of money to spend and has to spend
whole of his money on two goods.
3) Prices of goods are given and constant for him. He
cannot influence those prices.
4) Goods are homogeneous and divisible.
26.
27. There are three indifference curves IC1, IC2 and
IC3.
The price line PT is tangent to the indifference
curve IC2 at point C.
The consumer gets the maximum satisfaction or is
in equilibrium at point C by purchasing OE units of
good Y and OH units of good X with the given
money income.
The consumer cannot be in equilibrium at any
other point on indifference curves.
For instance, point R and S lie on lower
indifference curve IC1 but yield less satisfaction.
As regards point U on indifference curve IC3, the
consumer no doubt gets higher satisfaction but
that is outside the budget line and hence not
achievable to the consumer.
28. CONDITIONS CONSUMER
EQUILIBRIUM
At the equilibrium point, slope of indifference curve =
slope of price line
slope of indifference curve = MRS
slope of price line = PX / PY
Thus, at point J, MRS = PX / PY
The second order
condition is that indifference
curve must be convex to the
origin at the point of
tangency.
29. FACTORS AFFECTING THE INDIFFERENCE
CURVE
Price Effect: the effect due to the price
change of one commodity.
Income Effect: the effect due to the
change in income of the consumer.
Substitution Effect: the effect due only to
the relative price change in the
commodities.
30. SUMMARY
The indifference curve indicates what the
consumer is willing to buy
The budget line shows what the consumer is
able to buy
When the indifference curve and the budget
line are combined, we find the quantities of
each good the consumer is both willing and
able to buy
