Consumption
2. LAW OF EQUI-MARGINAL UTILITY
2.4. INDIFFERENCE CURVE ANALYSIS
The cardinal approach was found to be defective in many respects.
Hence modern economists have evolved the indifference curve approach, based on the ordinal system. The analysis was formulated by the famous Italian economist Pareto.
The indifference curve analysis is considered to be a geometric device representing all such combinations of two goods yielding equal satisfaction. An indifference curve represents different combinations of two goods that give the same level of satisfaction.
It can be defined as the "locus of points representing all the different combinations of two goods (say X and Y) which yield equal level of utility or satisfaction to the consumer.” Each point on the indifference curve indicates the same level of satisfaction as any other point on the same curve. Each indifference curve indicates only one level of satisfaction.
Assumptions
1. The consumer is interested in buying only two goods at a point of time. He is aware and has complete knowledge of the prevailing prices in the market.
2. The consumer is assumed to be rational person who with a given income, likes to choose the combination of goods that gives maximum satisfaction.
3. The analysis assumes continuity. Which means that consum-
ers are capable of ordering or ranking all combination of goods to the satisfaction they yield.
4. The consumer has a fixed amount of money which he likes to spend on two goods.
5. The prices of goods are assumed to be constant.
6. The consumer choice is transitive. That is, he is always consistent in his choice, i.e., when he prefers combination a to combination b, b to c, then he must also prefer a to c.
7. He is able to rank his preferences according to the satis- faction which he derives from them.
Indifference schedule
An indifference schedule is a list of alternative combinations in the stock of two goods which yield the same level of satisfaction to the consumer. The various combinations give the consumer equal satisfaction and as such he is indifferent to various combinations. When a consumer sets his preference for different combinations of certain goods under consideration, he will rank them according to the satisfaction he obtains from them. Thus the one yielding less satisfaction he prefers less, and one which gives him more satisfaction he prefers more.
Combination Commodity x Commodity y
A 5 20
B 7 17
C 9 15
D 11 11
E 13 9
From the schedule we can find that in the first combination A Commodity x is demanded less and commodity y is demanded more. And in the second combination B also x is demanded less and commodity y is demanded more. In the combination D both the commodities are demanded equally. And in the combination E more of Commodity x is demanded and less of Commodity y is demanded. It is seen here that all the combinations in the schedule give the consumer equal level of satisfaction.
Indifference Curve
The scale of preference of the consumer can be also explained through a figure. The combinations can be plotted on a graph. The various combinations of the two commodities are plotted and joined to form a curve called the indifference curve. In the figure IC is the indifference curve showing the combinations of the two commodities given in the schedule. All the points on this curve give the consumer the same level satisfaction. Hence an indifference curve represents the loci of various combinations of two goods which give the consumer equal satisfaction.
Indifference Map
The indifference curve in the above figure shows the consumer has only one indifference curve in which the various combinations of two commodities give a particular level of satisfaction. A consumer may have any number of such indifference curves for the two commodities showing the different levels of satisfaction.
Thus a set of indifference curves, which represent a lower satisfaction and a higher satisfaction is called the indifference map.
It can also be said that the indifference map represents a collection of many indifference curves which indicate a certain level of satisfaction.
In the figure units of oranges are measured on the y axis. And on the x axis units of mangoes. Each indifference curve shows different combinations of oranges and mangoes which give the
consumer the same satisfaction. At the point A on the IC1 the consumer demands 4 units of oranges and 2 units of mangoes.
And on Point B on the curve IC2 he demands 7 units of oranges and 4 units of mangoes and obtains a higher level of satisfaction.
And Point C on the indifference curve IC3 the consumer buys 6 units of oranges and 10 units of mangoes. The third combination gives more satisfaction than the combination 2 and 1. Thus it is seen that as the consumer prefers more units of both commodities, he moves on the higher indifference level and when he desires less units of both the commodities he moves down the indifference level. Thus the lower indifference curve gives him less satisfaction and higher indifference curve gives him a higher satisfaction. The set of indifference curves, which indicate the different levels of satisfaction, based on his scale of preference is called the indifference map.
CHARACTERISTICS OF THE INDIFFERENCE CURVES 1. Indifference curves slope down wards from left to right: The negative slope of the indifference curve indicates that when one commodity in the combination of another is increased, the amount of the other commodity is reduced. This is because the consumer has to remain on the same indifference curve. For instance if the
indifference curve is horizontal to X axis, as in Fig. A. the various points A,B,C,D, denoting various combinations of x commodity and y commodity may not have equal significance. At point B, the consumer gets more of x while the quantity of y remains constant. As the consumer moves along the indifference curve he is getting a fixed quantity of y but increasing quantities of x. so the consumer cannot be indifferent. On the other hand the indifference curve cannot be vertical also as indicated in Fig. B.
Here it is seen the consumer gets more of y commodity than at point C, B or A, while the x commodity remains constant. So
Fig ‘A’ Fig ‘B’
Fig ‘C
Commodity x
Commodity y
Commodity x Commodity x
the consumer cannot be indifferent to various combinations as they refer different level of satisfaction. In the upward sloping curve too as shown in Fig. C, the different points on the curve differ in significance because as the consumer moves from A to B, he gets more of x and more of y commodities. And he cannot be indifferent to the combinations.
2. Indifference curves are convex to the origin: The slope of the indifference curve measures the marginal rate of substitution (MRS). Thus convexity illustrates the law of diminishing marginal rate of substitution. It states that the consumer values less of a commodity which has a large stock. In the figure the indifference curve is convex to the origin. As the consumer moves downwards, commodity x becomes larger, and that of y becomes smaller. Hence each time the consumer substitutes x for y he will sacrifice a lesser amount of y in exchange of x.
3. Indifference curves are parallel to each other: Indifference curves can never intersect each other. There will be no intersection between the two indifference curves. This is because each indif- ference curve represents a specific level of satisfaction. Indifference curves analysis is based on transitivity. Transitivity implies con- sistency in choice making. It is assumed a rational consumer would always prefer a larger quantity to a smaller one.
For instance ‘b’ in the figure in the IC1 curve points a and b are combination that the consumer prefers to choose. And on the IC2 curve, points a and c are the combinations the consumer prefers and he is on the higher indifference level. If combinations a and b give the same level satisfaction when he is on indifference curve
1, and if combinations a and b are equal, then a and c should be equal. But they cannot be equal, because a is the indifference curve 1 and c is on the indifference curve 2. it is can thus be inferred that indifference curves cannot intersect.
4. Indifference curves do not touch the axis: According to the analysis the consumer is considering different combinations of two commodities. But if the indifference curve touches either the y axis or the x axis. The consumer consumes only one commodity.
If it touches the y axis as shown by point p in the figure (a),
Fig (a) Fig (b)
it means the consumer is satisfied with OP units of the y commodity. Similarly if the consumer prefers OM units of commodity x as indicated in the figure (b), it means he prefers only commodity x. In reality the consumer prefers to purchase both the commodities, thus the indifference curves do not touch the axis.