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Indifference Curve Analysis PPT

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Indifference Curve Analysis PPT

  2. 2. <ul><li>The technique of indifference curves was originated by Francis Y. Edgeworth in England in 1881. It was then refined by Vilfredo Pareto, an Italian economist in 1906. This technique attained perfection and systematic application in demand analysis at the hands of Prof. John Richard Hicks and R.G.D. Allen in 1934. </li></ul><ul><li>Hicks discarded the Marshallian assumption of cardinal measurement of utility and suggested ordinal measurement which implies comparison and ranking without quantification of the magnitude of satisfaction enjoyed by the consumer . </li></ul><ul><li>Professor Hicks introduced the concept of scale of preferences of a consumer as the base of indifference curve technique. The conceptual arrangement of different goods and their combinations in a set order of preferences is called the scale of preferences . </li></ul>
  3. 3. <ul><li>Assumptions </li></ul><ul><li>Rational behavior of the consumer </li></ul><ul><li>Utility is ordinal </li></ul><ul><li>Diminishing marginal rate of substitution </li></ul><ul><li>Consistency in choice </li></ul><ul><li>Transitivity in choice making </li></ul><ul><li>Goods consumed are substitutable </li></ul>
  4. 4. <ul><li>Definition : </li></ul><ul><li>An indifference curve is the locus of points representing all the different combinations of two goods which yield equal level of utility to the consumer. </li></ul><ul><li>Indifference Schedule : </li></ul><ul><li>Indifference schedule is a list of various combinations of commodities which are equally satisfactory to the consumer concerned. </li></ul>
  5. 5. Indifference Schedule: 5 5 E       4 6 D       3 8 C       2 11 B       1 15 A       Mangoes Apples Combinations      
  6. 6. Indifference curve IC shows all possible combinations of apples and mangoes between which a person is indifferent. Point A shows consumption bundle consisting of 15 apples and one mango. Moving from point A to Point B, we are willing to give up 4 apples to get a second mango (total utility is the same at points A and B).
  7. 7. Indifference Map : A graph showing a whole set of indifference curves is called an indifference map. All points on the same curve give equal level of satisfaction, but each point on higher curve gives higher level of satisfaction.
  8. 8. <ul><li>Properties of indifference curves : </li></ul><ul><li>Indifference curves are negatively sloped </li></ul><ul><li>Given a combination of commodity X and commodity Y, with every increase in X, the amount in Y should fall in order that the level of satisfaction from every combination should remain the same. </li></ul><ul><li>Indifference curves are convex to the origin </li></ul><ul><li>Convexity illustrates the law of diminishing marginal rate of substitution. </li></ul><ul><li>Indifference curves can never intersect each other </li></ul><ul><li>Indifference curves can never intersect each other because each indifference curve represents a specific level of satisfaction. If two indifference curves intersect each other, then at the point of intersection, the consumer is experiencing two different levels of utility. </li></ul>
  9. 9. <ul><li>Consumer Equilibrium </li></ul><ul><li>A consumer seeks a market basket that generates the maximum level of happiness. However, one’s money income and prices of goods imposes a limit on the level of satisfaction that one may attain. Thus, the income at the disposal of the consumer in conjunction with prices of the commodities will determine the budgetary constraint or the price line. </li></ul>
  10. 10. <ul><li>Consumer equilibrium is attained when, given his budget constraint, the consumer reaches the highest possible point on the indifference curve. The maximum satisfaction is yielded when the consumer reaches equilibrium at the point of tangency between an indifference curve and the price line. At point E, the price line is tangent to the indifference curve. </li></ul><ul><li>At the equilibrium point, slope of indifference curve = slope of price line </li></ul><ul><li>slope of indifference curve = MRS </li></ul><ul><li>slope of price line = PX / PY </li></ul><ul><li>Thus, at point E, MRS = PX / PY </li></ul><ul><li>Thus, satisfaction is maximized when the marginal rate of substitution of X for Y is just equal to the price of X to the price of Y. </li></ul>