Indifference Curve

Dr. Aruna Kumar Dash

IBS Hyderabad

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 What Indifference Curve Approach
Requires…
Indifference Curve Approach requires
consumers be able to rank their
preferences for various combinations of
goods

Specifically, the consumer should be able

to say whether
Combination A is preferred to combination B
Combination B is preferred to combination A.
or
Both combinations are equally preferred
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 What is an Indifference Curve?
Indifference curve shows all
combinations of goods that provide the
consumer with the same satisfaction, or
the same utility

Thus, the consumer finds all

combinations on a curve equally
preferred

Since each of the alternative bundles of

goods yields the same level of utility, the
consumer is indifferent about which
combination is actually consumed
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 Table:Indifference Schedule
Combination Burger Ice Cream

A 1 12
B 2 8
C 3 5
D 4 3
E 5 2

Indifference Schedule shows Different Combinations

of Two Goods which Give Equal Satisfaction or Utility
 Y Indifference Curve
Ice 12
A
cream 10

8 B
6 C
4 D E
2 IC
0 1 2 3 4 5 6 7 X
Burger

Thus, along an indifference curve, there is an

inverse relationship between the quantity of one
good consumed and the quantity of another
consumed  indifference curves slope down
 Indifference Map
It Exhibits Scale of Preferences between Different
Combinations on Different Indifference Curves

Higher Indifference
Y Curve Represents
Ice 12
Higher Satisfaction
cream 10
B C
8
6 A
IC3
IC2
4
2 IC1
0 1 2 3 4 5 6 7 X 6
 Slope is Marginal Rate of Substitution (MRS)

Combination Burger Ice MRSburger, ice cream

Cream
A 1 12
B 2 8 4
C 3 5 3
D 4 3 2
E 5 2 1
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 Slope of the Indifference Curve

Y
Ice
cream t

B
S
IC
0 T X
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 Principle of Diminishing MRS
It States that MRS of one good (Burger)will Decline as
more and more of that Good (Burger) is Substituted for
another good (Ice Cream)
Y4 Y3 Y2 Y1
Y Di min ishing MRS    
X X X X
Ice 12 Y1
cream X
10 4
Y2
8 X
Y3
3
6 X Y
4

4 2 X

2 1 IC

0 1 2 3 4 5 6 7 X
Burger
 Properties of Indifference Curve
Indifference Curves Slope Downward to
the Right
Y

A Accepted Ruled Out Ruled Out Ruled Out

A B
B
B B

IC A A
0 X

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 Second Property
Indifference Curves are Convex to
the Origin
Accepted Ruled Out Due
Ruled Out Due to Constant
Due to to Increasing MRS
A
Decreasing MRS
MRS
B

Problem of Monomania 11
 Third Property
Indifference Curves cannot Intersect
Each Other Indifference Curve
assumes the law of
Y Transitivity
In this case there is
Violation of Transitivity
C Law
A
IC1
B IC2
0 X

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 Fourth Property

Higher Indifference Curve Represents

a Higher Level of Satisfaction than the
Lower Indifference Curve

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 Budget Line
Budget line depicts all possible combinations of
Goods which the consumer can buy by spending his
given income on the goods at their Given prices

Px . Qx + Py . Qy =M

Where,
Px and Py are the prices of commodity X and Y and Qx, and Qy is their respective
quantities.
M= consumer’s money income
The Budget equation states that the consumer’s expenditure on commodity X and Y
cannot exceed his money income (M). Budget Line, also called as Budget
Constraint
Example: Given Income = Rs. 50
Price of Burger = Rs 10 per unit
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 Budget Line
Any Combination
Ice
P
Cream 10 above Budget Line is
H beyond the reach of the
8 Consumer
B Any Combination
6
below the Budget line is
4 within the capacity but
the consumer is not
2 spending whole money

L
0 1 2 3 4 5 Burger

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Effect of Changes in Price on Budget Line
Good Y Initial budget line is PL.
Price of good X Falls and Y
P remains same:
Budget Line Shifts to PL’
Price of Good X Rises:
Budget Line Shifts to PL’’

L’’ L L’ Good X
P’’ Price of good Y Falls:
Good Y
Budget Line Shifts to P’’L
P
P’ Price of Good Y Rises:
Budget Line Shifts to P’L
L Good X 16
Effect of Changes in Income on Budget Line

Initial budget line is PL

P’
Increase in Income:
P Budget Line Parallelly
Shifted from PL to P’L’
P’’ Decrease in Income:
Budget Line Parallelly
Shifted to P”L”

0 L’’ L L’

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Slope of the Budget Line
Good Y P

O L
Good X

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 Summary
The indifference curve indicates what the
consumer is willing to buy

The budget line shows what the consumer is able to

buy

When the indifference curve and the budget line

are combined, we find the quantities of each good
the consumer is both willing and able to buy

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 Consumer’s Equilibrium
Assumptions:

The Consumer has a fixed amount of money to

spend on the two goods. He has to spend whole of
his given money on the two goods

Prices of goods are given and constant for him

Goods are homogenous

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Ice Cream (Y)
Necessary Condition:
P Indifference Curve is
tangent to the budget line
R Slope of Indifference curve
= Slope of the budget line
S
MRSXY = PX/PY
5
E
IC4
T IC3
H IC2
IC1
0
3 L Burger (X)
 A rational consumer wants to maximize the
utility subject to the budget constraint.
PL is the budget line which shows all the combinations of X and Y
The consumer can purchase OL units of goods X if entire income is
spent on X
The consumer can purchase OP units of (goods) Y if entire income is
spent on Y
Any other combinations consumer buys different combinations of X
and Y
The consumer is equilibrium at point E where he consumes 3 units of
Burger and 5 units of ice cream. At point E both necessary and
sufficient conditions are fulfilled. Any other points both conditions are
not fulfilled.
Sufficient condition is that Indifference curve must be Convex to the
Origin at the Point of Equilibrium.
 Consumer’s Equilibrium
Second Order or Sufficient Condition:
At the Point of Equilibrium E, Indifference curve
Must be Convex to the Origin or MRSXY must be
falling First order condition i.e.
Good Y
MRSXY = PX/PY is Satisfied
P
U Second Order is not satisfied
as IC1 is Concave to the origin
J at Point J. Thus J is not a
T Stable Equilibrium
IC1

0 L
Good X
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Thank you

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