Transcript Indifference Curve Analysis

Indifference Curve Analysis
Kamal Singh
Lecturer in Economics
Contents
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What is Indifference curve
Marginal Rate of Substitutions
Properties of IC
Budget Constraints
Consumer Equilibrium with IC Analysis
Ordinal utility analysis
• The concept of Cardinal Utility was used by Marshal to
define Consumer's Equlibrium. Cardinal Utility means
consumer could measure the satisfaction derived by the
consumption of any goods or services in terms of
number and unit of that measurment is Utils or the
Money.
Where as Ordinal Utility means giving the rank to the
utility dervied by the consimption of goods and services.
This Concept was given by J.R. Hicks. This is more
realstic and better than cardinal utility. This is totally
based on Introspection.
• Indifference analysis is an alternative way of
explaining consumer choice that does not
require an explicit discussion of utility.
• Indifferent: the consumer has no preference
among the choices.
• Indifference curve: a curve showing all the
combinations of two goods (or classes of
goods) that the consumer is indifferent
among.
Assumptions
• Rational Consumer Ordinal Utility Non-Satiety
(More is Preferred to Less) Diminishing
Marginal Rate of Substitution.
• Consistency: If a consumer prefer A to B in one
period then he will not prefer B to A in
another period.
• Transitivity: If a consumer prefer A to B and B
to C, then he must prefer A to C.
Combination
Oranges
Apples
MRS
A
1
10
10:1
B
2
6
4:1
C
3
3
3:1
D
4
1
2:1
Marginal Rate of Substitution
Marginal rate of substitution – the rate at
which one good must be added when the
other is taken away in order to keep the
individual indifferent between the two
combinations.
Indifference Map
• An indifference map is a complete set of indifference
curves.
• It indicates the consumer’s preferences among all
combinations of goods and services.
• The farther from the origin the indifference curve is,
the more the combinations of goods along that curve
are preferred.
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Properties of IC’s
• The indifference curves are not likely to be vertical, horizontal,
or upward sloping.
– A vertical or horizontal indifference curve holds the quantity of one of
the goods constant, implying that the consumer is indifferent to
getting more of one good without giving up any of the other good.
– An upward-sloping curve would mean that the consumer is indifferent
between a combination of goods that provides less of everything and
another that provides more of everything.
– Rational consumers usually prefer more to less.
• The slope or steepness of indifference curves is
determined by consumer preferences.
– It reflects the amount of one good that a consumer must give up to
get an additional unit of the other good while remaining equally
satisfied.
– This relationship changes according to diminishing marginal utility—
the more a consumer has of a good, the less the consumer values an
additional value of that good. This is shown by an indifference curve
that bows in toward the origin.
Indifference Curves:
No Crossing Allowed!
• Indifference curves cannot cross.
• If the curves crossed, it would mean that the
same bundle of goods would offer two different
levels of satisfaction at the same time.
• If we allow that the consumer is indifferent to all
points on both curves, then the consumer must
not prefer more to less.
• There is no way to sort this out. The consumer
could not do this and remain a rational consumer
Higher indifference curve represents higher
satisfaction . This is because the combinations
lying on higher indifference curve contain
more of either one or both goods and more is
always preferred to less. More is preferred to
Less Indifference map
Indifference Map
• An indifference map is a complete set of
indifference curves.
• It indicates the consumer’s preferences among
all combinations of goods and services.
• The farther from the origin the indifference
curve is, the more the combinations of goods
along that curve are preferred
Budget Constraint
• The indifference map only reveals the
ordering of consumer preferences among
bundles of goods. It tells us what the
consumer is willing to buy.
• It does not tell us what the consumer is able
to buy. It does not tell us anything about the
consumer’s buying power.
• The budget line shows all the combinations of
goods that can be purchased with a given level
of income
• The mathematical expression for budget
constraint is:
M= Px X + Py Y
Y= M/Py – Px/Py
Example: Y = Rs 200
Px= Rs 2
Py= Re1
Consumer Equilibrium
• 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.
• The demand curve for a good can be derived
from indifference curves and budget lines by
changing the price of one of the goods
(leaving everything else the same) and finding
the equilibrium points.
Consumer Equilibrium
Deriving the Demand Curve