INDIFFERENCE CURVES

APPROACH
 Introduction to Utility
Utility analysis is based on the assumption
that cardinal measurement of utility is
possible. Utility can be expressed in cardinal
numbers. The consumer can be best compare
the satisfaction derived from different goods
or from different units of the same good.
Introduction to indifference Curves
An indifference curve is a curve which shows
different combinations of two commodities
yielding equal satisfaction to the consumer. It
means all the points located on an
indifference curve represent such
combinations of two commodities as yield
equal satisfaction to the consumer.
Introduction to indifference Curves (cont…)

A curve used in economics which shows

how consumers would react to
different combinations of products. On the graph, a
quantity of one product appears on the x axis and a
quantity of another product appears on the y axis.
Consumers would be equally satisfied at any point
along a given curve, as each point
brings the same level of utility to that consumer. The
slope of the curve is referred to as the marginal rate
of substitution.
According to H.L. Varian, “An IC represents all
combinations of two commodities that
produced the same level of satisfaction to a
person. That person is therefore indifferent
among the combinations represented by the
points on the curve”.
 Indifference Schedule
• An indifference schedule refers to a table showing
different combinations of two commodities which
yield equal satisfaction. A consumer, therefore, gives
equal importance to each of the combinations.
Combination Apples Oranges
A 1 22
B 2 14
C 3 10
D 4 8
 Indifference Curves
An indifference curve shows a set of
consumption bundles among which the
individual is indifferent
Quantity of Y
Combinations (X1, Y1) and (X2, Y2)
provide the same level of utility

Y1

Y2 U1

Quantity of X
X1 X2
 Indifference Map
Indifference map is the graph which represents a
group of indifference curves each of which express
a given level of satisfaction.
Y I4
I3
I2 Indifference
I1 Map

F
Oranges
G
D

I4>I3>I2>I1

O X
Apples
 Indifference Curve Map
• Each point must have an indifference curve through it

Quantity of Y

Increasing utility

U3 U1 < U2 < U3
U2
U1
Quantity of X
 Law of Marginal rate of substitution
• Law of marginal rate of substitution is
discovered by Lerner, Hicks & Allen.
It is the rate at which the consumer can
substitute one good for another without
changing the level of satisfaction. It
determines the slope of indifference curve.

MRSxy = Decrease in consumption of Y

Increase in consumption of X
• Constant marginal rate of substitution
• Increasing marginal rate of substitution
• Diminishing marginal rate of substitution

Why does marginal rate of substitution

diminish?
• Constant Marginal Rate of Substitution - The
marginal rate of substitution of perfect substitutes
is constant if to obtain one more unit of X, only one
unit of Y is sacrificed to maintain the same level of
satisfaction.
Combination Apples Oranges Marginal Rate
of Substitution

A 1 10
B 2 9 1:1 or (1/1)
C 3 8 1:1 or (1/1)
D 4 7 1:1 or (1/1)
 Constant Marginal Rate of Substitution

Y
Constant
10 A
MRSxy

B
9
Oranges

8 C

7 D

IC

O 1 2 3 4 X
Apples
• Increasing Marginal Rate of Substitution. The
marginal rate of substitution of perfect substitutes
is increasing if to obtain one more unit of X, more
and more units of Y are sacrificed to maintain the
same level of satisfaction. The slope of indifference
curve is concave to the origin as shown in figure.
Combination Apples Oranges Marginal Rate
of Substitution
A 1 10
B 2 9 (1) 1:1 or (1/1)
C 3 7 (2) 1:2 or (1/2)
D 4 4 (3) 1:3 or (1/3)
 Increasing Marginal Rate of Substitution.
Y

A Increasing
10
MRSxy
B
9

C
7
Oranges

D
4

O 1 2 3 4 X
Apples
• Diminishing Marginal Rate of Substitution. The
MRS is decreasing if to obtain one more unit of X,
less and less units of Y is sacrificed to maintain the
same level of Satisfaction.

Combination Apples Oranges Marginal Rate

of Substitution
A 1 10
B 2 7 (3) 1:3 or (1/3)
C 3 5 (2) 1:2 or (1/2)
D 4 4 (1) 1:1 or (1/1)
Diminishing Marginal Rate of Substitution.

Y
Diminishing
10 A
MRSxy
1:3
3 MRSxy
7 B
1
1:2
2
Oranges

MRSxy
C 1:1
5
1 MRSxy
1 D
4
1

O 1 Apples 2 3 4 X
 Why Does the Marginal Rate of
Substitution Diminish?
• Law of diminishing marginal rate of substitution
conforms to law of diminishing marginal utility.
According to Law of diminishing marginal utility, as
a consumer increases the consumption of a good,
its marginal utility goes on diminishing.
• Consumer will be willing to give up less and less
units of oranges for every additional unit of apple.
• Marginal rate of substitution of apples for oranges
diminishes.
 Assumptions
• Rational Consumer
• Ordinal Utility
• Diminishing marginal rate of substitution
• Non satiety
• Consistency in selection
 Properties
• An IC generally slopes downward from left to
right.
• Convex to the point of origin.
• Two IC never touch or intersect each other.
• Higher IC indicates higher satisfaction.
• IC should generally not touch X axis nor Y axis.
• IC need not be parallel to each other.
 Some exceptional shapes of IC
• Straight line Indifference curve - perfect
substitutes: Two goods are perfect substitutes
if consumer is willing to substitutes one good
for the other at a constant rate.

• L shaped (righted angled) indifference curve –

perfect complements: Perfect complements
are goods that are always consumed together
in fixed proportions.
• Horizontal indifference curve – a good that
gives zero satisfaction: when a good gives no
satisfaction at all, a person would be unwilling
to sacrifice even the smallest amount of other
goods to obtain any quantity of the good.

• U shaped indifference curve - a good that

gives negative utility.
 BUDGET LINE
An indifference curve cannot possibly predict
consumer behaviour because it leaves two
important types of information, the income of
the consumer and the price of the
commodities. Price and income information is
supplied in an indifference diagram by
another curve which is called the budget line
or price line.
• According to Hibbdon, “the budget line is that
line which shows all the different
combinations of the two commodities that a
consumer can purchase given his money
income and the price of the two
commodities”
BUDGET LINE OR PRICE LINE
Income (Rs) Apples Price = Oranges Price =
(Re 1.00) (Re 0.50)
Four 0+ 8
Four 1+ 6
Four 2+ 4
Four 3+ 2
Four 4+ 0
 Y
Budget Line
10 A

6 C
Oranges

4 D

2 E

B
O 1 Apples 2 3 4 X
• Properties of Budget Line.
• It will be a straight line.
• It will have a negative slope.
• Slope of budget line = (-)
 Shifting of the Budget Line or Price Line.
• Change in Income. If prices of the two goods
remain unchanged,
Y
With increase in
income, budget line C

shifts to the right as A

shown by the line CD.

Oranges
E Rise in Income
Likewise, if income
decreases, budget line
will shift to the left, as Fall in
Income
shown by the EF line,
its slope remaining 1
F
2
B
3
D
4
X
O Apples
the same.
 A proportionate Change in All prices

• Due to proportionate Y
change in prices the C

position of the budget Fall in Price

line will change but A

the slope of the budget Oranges

line will not change.
E

Rise in Price
F B D
O 2 Apples 4 6 X
 Change in the Price of One Commodity
• If income of the
Y
consumer and price A
of one commodity
Fall in Price of
remain unchanged Apples
but the price of the
Oranges
other commodity
changes then the Rise in
Price of
slope of budget line Apples

will also change. D B C

O Apples X
 Consumer’s Equilibrium –
Indifference Curve Analysis.
• Consumer’s equilibrium
refers to a situation in
which a consumer with
given income and given
prices purchases such a
combination of goods
and services that gives
him maximum satisfaction
and he is not willing to
make any change in it.
 Assumptions
▫ Consumer’s income is constant.
▫ Consumer knows the price of all things
▫ Consumer can spend his income in small
quantities
▫ Consumer is rational and so maximizes his
satisfaction from the purchase of the two
goods.
▫ Consumer is fully aware of the indifference
map
▫ Goods are divisible.
 Conditions of Consumer’s Equilibrium

• In the words of Koutsoyiannis, “Two main

conditions of consumer’s equilibrium” are.
1. Price Slope of Indifference Curve = Slope of Budget or
Price line or

MRSxy =

2. Indifference curve should be convex to the

point of origin.
 CONSUMERS EQUILIBRIUM
• At equilibrium point ‘D’,
slope of indifference Y Budget Line

curve and price line 8 A

coincide. Slope of price Equilibrium Point
line is indicative of 6 C Of Consumer

marginal rate of
D Indifference Curve
substitution of good Oranges 4
X for Y (MRSxy) and IC3
slope of price line is IC2
2
indicative of the ratio E IC1
of price of good X (Px) B
O 1 2 3 4 X
and price of good Y(Py) Apples