Indifference Curve Analysis
Indifference Curve Analysis
Indifference Curve Analysis
Kishor Bhanushali
Indifference Curve Analysis
The indifference curve Indifference Schedule
analysis is a technique
Combinati Apples Mangoes
for explaining how on
choices between two A 15 1
alternatives are made.
Indifference curve is B 11 2
locus of different
C 8 3
combinations of two
commodities between D 6 4
which consumer is
indifferent E 5 5
Properties of indifference curve
1. Indifference curves will be
downward sloping
2. Tow indifference curves cannot
intersect or touch each other
3. An indifference curve must of
convex to the origin
Indifference Curve & Map
Indifference Curve Indifference Map
Y
Y
a A
a’ B
C
a”
IC
IC IC IC
0 X
0 b b’ b” X
Budget Line or Budget Constraints
Budget line shows all possible
combinations of two goods that the
consumer can buy if he spends the
whole of his given sum of money on
his purchase at the given prices
Shift in budget line due to change in
income, prices reaming the same
Shift in budget line due to change in
prices, income remaining the same
Marginal Rate of Substitution
MRS refers to the amount of one good that an
individual is willing to give up for an additional
unit of another good while maintaining the
same level of satisfaction or remaining on the
same indifference curve
Indifference Schedule
Combination Apples Mangoes MRS
A 15 1 -
B 11 2 4
C 8 3 3
D 6 4 2
E 5 5 1
( X )( MUx) ( Y )( MUy )
MUx / MUy Y / X
The Equilibrium Position of Tangency
The consumer is in equilibrium when he
maximizes his utility, given his income and
market prices of the commodities.
E
A
IC3
IC2
IC1
0 V
B
Degree of Substitutability and Indifference Curves
Ordinary
Y Good Perfect Perfect
Y Y
Substitutes Complements
o Xo X o X
Derivation of the Demand Curve through
Indifference Curve
Through Price Consumption Curve
PCC represents successive points of
tangency between the different budget
lines and the indifference curves.
Income Consumption Curve
Income consumption curve shows how the
consumption of two goods is affected by
changes in income when prices of both the
goods are given and constant.
ICC shows the effect of the changes in income
on the equilibrium quantities purchased of two
commodities.
The commodity is said to be normal if the
consumer consumes more units of the
commodity as his income increases, prices
remaining the same (ICC will be upward
sloping)
If consumer purchases less units of one of the
commodity as his income increases, the
commodity is said to be inferior (ICC will be
backward bending)
Income Effect
Income effect is change in the
consumption of a good arising out of
the change in the purchasing power
of money, which occurs due to price
change.
Substitution Effect
The substitution effect measures the
change in the purchase ofa good, which
arises out of the changes in its relative
prices alone.
The Slutsky measure of substitution effect
Budget line is shifted in such a way that
the consumer can purchase, if he likes to
purchase, the previous combination
New budget line passes through the initial
equilibrium point
Price Effect
Price Effect = Substitution Effect+ income effect
Y Price Effect = M1M3
Substitution Effect = M1M2
A
Income Effect = M2M3
S
R
IC3
IC2
IC1
0 M1 M2 B M3 E CX