Economics

project
Topic: INDIFFERENCE CURVE ANALYSIS

SubmittedTo: Neeraj Kaur chaudhary

Submitted by: sahil kakkar

BALLB(HONS)3RD SEMESTER
18203

RAYAT COLLEGE OF LAW

Acknowledgement
In performing my project, I had to take the help and guideline of some
respected persons, who deserve my greatest gratitude. The completion
of this project gives me much pleasure.
I would like to show my gratitude to ms.Neeraj kaur, Rayat College of
Law for giving me a good guideline for project throughout numerous
consultations. His dynamism, vision, sincerity and motivation have
deeply inspired me. I would also like to extend my deepest gratitude to
all those who have directly and indirectly guided me in typing this
project.
In addition, I would like to thank our Professor for introducing me to the
Methodology of work, and whose passion for the “underlying
structures” had lasting effect. I thank all the people for their help
directly and indirectly to complete my project.

INTRODUCTION
In microeconomics, indifference curve is an important tool of analysis
in the study of consumer behavior. The concept of indifference curve
analysis was first propounded by British economist Francis Ysidro
Edgeworth and was put into use by Italian economist Vilfredo Pareto
during the early 20th century. However, it was brought into extensive
use by economists J.R. Hicks and R.G.D Allen. Hicks and Allen
criticized Marshallian cardinal approach of utility and developed
indifference curve theory of consumer’s demand.
Thus, this theory is also known as ordinal approach. Indifference curve
analysis is a modern method to analyse consumer’s behaviour. It is
based on ordinal utility. There are two concepts of utility cardinal and
ordinal. Cardinal is used to count or indicate how many while ordinal
are words that represent rank and order in a set, scale of preference and
the marginal rate of substitution. Ordinal utility refers to the level of
satisfaction. The ordinal utility function means the utilities obtained
from goods can be compared as being greater or less or equal through
the level of satisfaction. The scale of preference is the quantitative
expression of consumer’s desire for goods. It shows the way in which an
individual consumer decides to spend his money income on various
commodities.
Meaning of Indifference Curve
An indifference curve is the locus of points – particular combinations
which yield the same utility or level of satisfaction to the consumer, so
that he is indifferent as to particular combination he consumes. In other
words, IC analysis refers to the locus of points representing the various
combinations of two goods which yield the same level of satisfaction to
the consumer. Since any combination of the two goods on an
indifference curve gives equal level of satisfaction, the consumer is
indifferent to any combination he consumes. Thus, an indifference curve
is also known as ‘equal satisfaction curve’ or ‘Iso -utility curve’. On a
graph, an indifference curve is a link between the combinations of
quantities which the consumer regards to yield equal utility. Simply, an
indifference curve is a graphical representation of indifference schedule.
•According to Hicks: “It is the locus of the points representing parts of
quantities between which the individual is indifferent and so it is termed
as an indifferent curve.”
•According to Leftwhich : “A single indifference curve shows the
indifferent combination of X and Y that yield equal satisfaction to the
consumer”

Indifference Map:
The Indifference Map refers to a set of Indifference Curves that reflects
an understanding and gives an entire view of a consumer’s choices. The
below diagram shows an Indifference map with three indifference
curves. According to the indifference curve approach, it is not possible
for the consumer to say how much utility he derives from the
consumption of a commodity, because utility is not a measureable
magnitude. But a consumer can compare two or more combinations of
goods and say which of them he likes best or whether he likes them all
equally well. The Laws of Consumer Demand can be deduced from
these preferences.

ASSUMPTIONS OF INDIFFERENCE CURVE

The indifference curve approach is based upon the following
assumptions:
1. Non-Satiety:
A rational person will prefer a larger quantity of a good than a
smaller amount of it. It is assumed that the consumer has not yet
reached the satisfaction point in respect of competition of a good.
Satiety means saturation. And, indifference curve theory assumes
that the consumer has not reached the point of satiety. It implies that
the consumer still has the willingness to consume more of both the
goods. The consumer always tends to move to a higher indifference
curve seeking for higher satisfaction.
2. Transitivity:
The consumer is supposed to be consistent about his tastes and
preference. For example if he prefers A to B and B to C then it follows
that he also prefers A to C. This assumption is called Transitivity.

3.Diminishing marginal rate of substitution:

Marginal rate of substitution may be defined as the amount of a
commodity that a consumer is willing to trade off for another
commodity, as long as the second commodity provides same level of
utility as the first one.
4. Two commodities
5.It is assumed that the consumer has fixed amount of money, all of
which is to be spent only on two goods. It is also assumed that prices of
both the commodities are constant.
6. As indifference curve theory is based on the concept of diminishing
marginal rate of substitution, an indifference curve is convex to the
origin.
7. Rational consumers
8. According to this theory, a consumer always behaves in a rational
manner, i.e. a consumer always aims to maximize his total satisfaction
or total utility.
PROPERTIES OF INDIFFERENCE CURVE
 There are four basic properties of an indifference curve. These
properties are  An indifference curve can neither be horizontal line
nor an upward sloping curve. This is an important feature of an
indifference curve.
 When a consumer wants to have more of a commodity, he/she will
have to give up some of the other commodity, given that the
consumer remains on the same level of utility at constant income.
As a result, the indifference curve slopes downward from left to
right.
 The slope of the indifference curve is called the MRS which is the
ratio of the marginal utilities of the two commodities. This is
expressed as MRS x,y = – ΔY /ΔX = MUx /MUy.
 Indifference curve is convex to the origin .
  As mentioned previously, the concept of indifference curve is
based on the properties of diminishing marginal rate of
substitution.
 According to diminishing marginal rate of substitution, the rate of
substitution of commodity X for Y decreases more and more with
each successive substitution of X for Y.
 Also, two goods can never perfectly substitute each other.
Therefore, the rate of decrease in a commodity cannot be equal to
the rate of increase in another commodity.
AN INDIFFERENCE CURVE CANNOT INTERSECT OR
TOUCH ANOTHER INDIFFERENCE CURVE
 This can be proved by showing that if two indifference curves on
the same indifference map intersect, there is logical contradiction
(or inconsistency). Suppose I1 , and I2 intersect as in Fig, then
from I1
 Point A lies on both I1 , and I2 . Since point A I2 like point C lies
on I1 the consumer is indifferent between A and C. Similarly we
can say that the consumer is indifferent between A and B.
Applying the transitivity assumption, then we can say that our
consumer is indifferent between B and C.
 But this is absurd since B contains more X than C while both B
and C contain the same amount of Y. We know that more is better
(showing higher utility) for the consumer. Hence B should be
strictly preferred to C, or B and C cannot show equal level of
utility. This explains why indifference curves cannot intersect.
 [ . . . Transitivity implies that if A is preferred to B and B is
preferred to C then A is preferred to C.]
TWO INDIFFERENCE CURVES CANNOT INTERSECT
 In this image, IC1 and IC2 are two indifference curves and C is the
point where both the curves intersect.
 According to indifference curve theory, satisfaction at point C =
satisfaction at point A Also, satisfaction at point C = satisfaction at
point B But, satisfaction at point B ≠ satisfaction at point A.
 Therefore, two indifference curves cannot intersect. Yet, two
indifference curves need not be parallel to each other.
 Higher indifference curve represents higher level of satisfaction .
 Higher the indifference curves, higher will be the level of
satisfaction. This means, any combination of two goods on the
higher curve give higher level of satisfaction to the consumer than
the combination of goods on the lower curve.

HIGHER INDIFFERENCE CURVE REPRESENTS HIGHER

LEVEL OF SATISFACTION
In the above figure, IC1 and IC2 are two indifference curves, and IC2 is
higher than IC1. We can also see that Q is a point on IC2 and S is a point
on IC2. Combination at point Q contains more of both the goods (X and
Y) than that of the combination at point S. We know that total utility of
commodity tends to increase with increase in stock of the commodity.
Thus, utility at point Q is greater than utility at point S, i.e. satisfaction
yielded from higher curve is greater than satisfaction yielded from lower
curve.

THE BUDGET (PRICE) LINE

 In search for higher utility, the consumer faces a constraint — a
limited budget or income. The consumer does not have sufficient
funds to purchase all combinations of the two goods. The limits
imposed by the budget are shown through the consumer’s budget
line. A budget line incorporates information on both the limited
income of the consumer to spend and the prices of two
purchasable goods.
 A budget line is a locus of points showing alternative
combinations of two goods that can be purchased with a fixed
amount of money income and fixed prices of the two goods.
 If we know the budget (or the spending power) of the consumer
and his Indifference Map we can find out what quantity of each
commodity he will purchase. With the same information we can
measure the effect of changes in the prices of commodities and of
changes in the income of the consumer.
 Suppose a consumer has a fixed income M which he spends on
two goods X and Y. Suppose Px is the price of X and Py is the
price of Y. Let OA be the amount of Y which can be purchased if
the whole of the consumer’s income (M) is spent on Y. Then OA
x Py = M. Or OA = M/Py. Similarly, let OB be the amount of X
which can be purchased with M. Then OB x px = M. Join A and
B. AB is called the Price Line or the Budget Line or the
Consumption-Possibility Line (See Fig. 4.9). The line AB has
important characteristics. Every point on it shows a possible
distribution of the consumer’s income (M) between X and Y.
 A budget line is derived from a given income and given prices. So
any change in income or price leads to a new budget line.  If the
price of one of the purchasable commodities falls there is a change
in the slope of the budget line.
 The slope of the line is:
 OA ÷ OB = M/py ÷ M/px = M/py. py/xy = px/py.
 This is known as the price ratio. The equation of the budget line is
M = Px. X + Py. Y.

EQUILIBRIUM OF THE CONSUMER

 The equilibrium position of the consumer is shown in Fig. 4.10. We
assume a consumer with a fixed income M, spending the whole of his
income only on two goods, X and Y. AB is the consumption possibility
line and IC1 , IC2 etc. are the indifference curves of the consumer.
 The consumer may with M, buy OC of X and NC of Y. In this case he
is on indifference curve IC1 . But with the same income M, he can also
buy OM of X and PM of Y. In this case he is on IC3 which denotes a
better situation than IC1 . It can be assumed, as a rule of rational
behaviour, that the consumer will try to secure the maximum possible
satisfaction from his income. He will, therefore, be on the highest
indifference curve that he can reach with his income.
 A glance at Fig. 4.10 shows that the highest indifference curve the
consumer can reach is IC3 which just touches the consumption
possibility line AB. AB is the tangent of IC3 at P. Once the consumer
reaches this position he will not shift his purchase pattern, unless his
income changes or unless the price of X or of Y becomes different.
From this reasoning we can conclude that the equilibrium position of
the consumer is at the point where the Consumption Possibility Line is
the tangent of an Indifference Curve.
 The rate of decrease in consumption of coffee is not the same as rate of
increase in consumption of cigarette.
 Similarly, rate of decrease in consumption of coffee has gradually
decreased even with constant increase in consumption of cigarette.
Thus, indifference curve is always convex (neither concave nor
straight).
 Indifference curve cannot intersect each other Each indifference curve
is a representation of particular level of satisfaction.
 The level of satisfaction of consumer for any given combination of two
commodities is same for a consumer throughout the curve. Thus,
indifference curves cannot intersect each other.
 CONVEX INDIFFERENCE CURVES AND CORNER
EQUILIBRIUM
 When a consumer’s preferences are such that he likes to consume some
amount of both the goods, he reaches an equilibrium position at the
point of tangency between the budget line and his indifference curve.
 This equilibrium position at the point of tangency which lies within
commodity space between the two axes is often called interior solution.
 The economic implication of the interior solution is that consumer’s
pattern of consumption is diversified that is, he purchases some amount
of both the commodities. Our knowledge of the real world tells us that
consumer’s pattern of consumption is quite diversified and they often
buy a basket or bundle of several different goods instead of spending
their entire income on a single commodity.
 In the context of two commodity model which is generally assumed in
indifference curve analysis, assumption of diversification in
consumption and an interior solution, which imply that consumer
purchases some amount of both goods, is correct.
 However, in the real world o many commodities we often find that a
typical consumer does not buy positive amounts of a the goods and
services available in the market. In fact, a typical consumer buys only a
small number of goods available in the market.
Convex Indifference Curves and Corner Equilibrium:
 The reason for not purchasing a commodity by a consumer may be that
the price or opportunity cost of that particular commodity may be too
high for him. One may like to have Maruti car, air conditioner or a
 colour TV, but may not actually have it on account of their prices being
too high. The indifference curve analysis enables us to explain even this
phenomenon. Consider Figure where indifference map between two
goods X and Y and budget line BL are such that the interior solution is
not possible and consumer in its equilibrium position at point B will not
consume any quantity of commodity X.
 This is because as seen in the Figure the price of commodity X is so
high that budget line is steeper than the indifference curves between the
two commodities. In economic terms it means that the price or
opportunity cost of commodity X in the market is greater than the
marginal rate of substitution of X for Y which indicates willingness to
pay for the commodity x.

 On the other hand, in Figure the indifference map between the two
goods is such that the budget line BL is less steep than the indifference
curves between the two goods so that the MRSy > PX /Py for all levels
of consumption along the budget line BL. Therefore, he maximizes his
satisfaction at the corner point L where he buys only commodity X and
none of Y. In this case price of commodity Y and willingness to pay
(i.e. MRS) for it are such that he does not consider it worthwhile to
purchase even one unit of it.
 the indifference curves are usually convex to the origin. Convexity of
indifference curves implies that the marginal rate of substitution of X
for Y falls as more of X is substituted for Y.Thus, indifference curves
are convex to the origin when principle of diminishing marginal rate of
substitution holds good and which is generally the case. But the
possibility of indifference curves being concave to the origin cannot be
ruled out in some exceptional cases. Concavity of the indifference
curves implies that the marginal rate of substitution of X for y increases
when more of X is substituted for Y.
 It will be clear from the analysis made below that in case of
indifference curves being concave to the origin the consumer will
choose or buy only one good. In other words, concavity of indifference
curves implies that the consumer has a distaste for variety, that is, does
not like diversification in consumption. However, distaste for variety
cannot be considered a normal or model behaviour, so we regard
convexity to be the general case. But when consumers have a distaste
for variety and diversification the case of concave indifference curves
will occur.
 In case of concave indifference curves, the consumer will not be in
equilibrium at the point of tangency between budget line and
indifference curve, that is, in this case interior solution will not exist.
Instead, we would have corner solution for consumer’s equilibrium. Let
us take Fig. here indifference curves are shown to be concave. The
given budget line BL is tangent to the indifference curve IC2 at point Q.
 But the consumer cannot be in equilibrium at Q since by moving along
the given budget line BL he can get on to higher indifference curves
and obtain greater satisfaction than at Q. Thus by moving to K on the
given budget line BL, he will get more satisfaction than at Q since K
 lies on a higher indifference curve than Q. He can increase his
satisfaction still more by moving to point Z on the budget line BL. 
 Thus, as he moves upward from tangency point Q on the budget line
his satisfaction will go on increasing until he reaches the extremity
point B. Likewise, if from Q he moves downward on the budget line, he
will get on to higher indifference curves and his satisfaction will go on
increasing till he reaches the other extremity point L. 
 In these circumstances the consumer will choose only one of two
goods: he will buy either X or Y depending upon whether L or B lies on
the higher indifference curve. In the situation depicted in Fig point B
lies on a higher indifference curve than point L. Therefore, the
consumer will choose only Y and will buy OB of Y. It should be
carefully noted that at B the budget line is not tangent to the
indifference curve IC5 , even though the consumer is here in
equilibrium. It is clear that when a consumer has concave indifference
curves, he will succumb to monomania, that is, he will consume only
one good

.
LIMITATIONS
Indifference curve analysis is claimed to be superior to utility analysis
because of its closeness to the reality. But, still it is criticised by many
economists due to some unrealistic assumptions, it is based upon.
Further, Schumpeter says, “The new technique has neither proved
anything new, nor has proved anything old, wrong”.  Robertson
blamed this analysis by pointing out it as an old wine in a new bottle.
Many other economists such as F.H. Knight, Armstrong, Boulding
 criticised the analysis in several ways. Some of the limitations of this
analysis are:
 The indifference curve analysis is utility analysis in a new grab. It has
simply substituted new concepts and equations instead of the old ones.
The old principle of diminishing marginal utility has been replaced by
the new principle of diminishing marginal rate of substitution. The old
equation of consumer equilibrium.  MUA /PA = MUB /PB = MUM  is
replaced by a new equation, which says that the consumer is in
equilibrium, when the marginal rate of substitution between the two
commodities, which is the ratio of their marginal utilities is equal to
their price ratio. This is nothing but the reformulation of previous
equation in a modified form.
 Indifference curve analysis assumes that consumers are familiar with
their preference schedules. But, it is not possible for a consumer to have
a complete knowledge of all the combinations of the two commodities,
total satisfactions from them, rates of substitutions and total incomes.
At best he can tell his preferences in the neighbourhood of his existing
position. Moreover, the preferences of this consumer keep changing.
 This analysis assumes perfect divisibility of the commodities. But,
consumer is often faced by lumpy units. So, the continuity of
indifference curves is not ensured as assumed by indifference curves
analysis, as also large number of very closed placed indifference
curves. Further, choices with extreme combinations (too much of
commodity ‘X’ and very little of ‘Y’ and vice-versa) are not observed
in the real world.
 Indifference curve analysis is micro economic in character. It is not
possible to draw indifference curves indicating the choices of a group or
a country as a whole. In this respect, utility analysis has an edge over,
as it goes by a general opinion based on past experience and
observation.
 Indifference curve analysis is not amenable to statistical investigation
and empirical research, as the entire analysis is based upon theoretically
formulated crosseffect relationships and not upon statistical
observations. In view of Samuelsson, indifference curves are imaginary.
 Indifference curve analysis fails to explain consumer behaviour under
risk and uncertainty.
 Thus, indifference curve analysis is not free from defects of its own.
Even some of these defects were appreciated by Hicks, who sought to
remove them in his later work ‘A Revision of Demand Theory’
published in 1956. The approach is a considerable improvement over
the conventional utility approach and has gained popularity among
economists.

CONCLUSION
In our analysis above, we have shown that corner solution of consumer
s equilibrium is possible even when his indifference curves between
goods are convex. It is worth noting that in case of convex indifference
curves, corner equilibrium is however not inevitable, it occurs only
when price of a commodity is too high as compared to the marginal rate
of substitution of even the first unit of the commodity.  However, when
the indifference curves are concave consumer’s equilibrium will
inevitably be a corner solution. This implies that more of commodity X
a consumer has the more useful or significant in terms of satisfaction an
extra unit of it becomes. Therefore, the concave indifference curves do
not seem to be plausible or realistic.  Now, as seen above, the
concavity of indifference curves for a consumer implies that the
consumer spends his entire income on a commodity and therefore buys
only one commodity. However, consumption of one good only by a
consumer which the concavity of indifference curves leads us to believe
is quite unrealistic. Observations in the real world reveal that consumers
do not spend their entire income on a single commodity and in fact
purchase a multitude of different goods and services. This rejects the
existence of concave indifference curves.