INDIFFERENCE CURVE ANALYSIS ISA EXPLANATION OF ORDINAL UTILITY

2. OBJECTIVE :-
1. Introduction of Indifference Curve
2. Definition of Indifference Curve
3. Assumptions
4. Constructing an indifference curve
5. Indifference Schedule
6. Indifference Map
7. Marginal Rate Of Substitution (MRS)
8. Properties of Indifference Curves
9. Consumer Equilibrium

3. INDIFFERENCE CURVES
 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.
 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 .

4. DEFINITION
• An Indifference curve (IC) is the locus of all those
combination of two goods which give the same level of
satisfaction to the consumer so that an individual is
indifferent..
 In other words, consumer gives equal preference
to all such combinations.

5. Assumptions:
 Rational behavior of the consumer
 Utility is ordinal
 Diminishing marginal rate of substitution
 Consistency in choice
 Transitivity in choice making
 Goods consumed are substitutable
• Transitivity
– if A is preferred to B, and B is preferred to C, then A is preferred to C
– assumes that the individual’s choices are internally consistent
 Continuity
 if A is preferred to B, then situations suitably “close to” A must also be
preferred to B
 used to analyze individuals’ responses to relatively small changes in
income and prices

6. Constructing an indifference curve
 Indifference schedule is a list of various
combinations of commodities which are equally
satisfactory to the consumer concerned.
Combination Apples Oranges
A 1 22
B 2 14
C 3 10
D 4 8
E 5 7
INDIFFERENCE SCHEDULE

7. INDIFFERENCE CURVES
Combination Apples Oranges
A 1 22
B 2 14
C 3 10
D 4 8
E 5 7
12
10
8
6
4
2
0
1 2 3 4 5
A(1, 22)
24
22
20
18
16
14
Apples
Oranges
IC1

8. Indifference Map :
A graph showing a whole set of indifference curves is called an
indifference map.
0
5
10
15
20
25
0 1 2 3 4 5
Mangoes
Apples
IC1
IC2
IC3

9. MARGINAL RATE OF SUBSTITUTION (MRS)
The marginal rate of substitution of X for Y (MRSxy) is defined
as the amount of Y, the consumer is just willing to give up to get
one more unit of X and maintain the same level of satisfaction.
MRSxy = Decrease in the Consumption of Y
Increase in the Consumption of X
= (-) ∆Y
∆X
DIMINISHING MARGINAL RATE OF SUBSTITUTION
Combination Apples Oranges MRS
A 1 22 ---
B 2 14 8:1
C 3 10 4:1
D 4 8 2:1
E 5 7 1:1
As the consumer increases the consumption of apples, then for getting every
additional unit of apples, he will give up less and less of oranges, that is, 8:1, 4:1,
2:1, 1:1 respectively This is the Law of Diminishing MRS.

10. LAW OF DIMINISHING MRS
MRS is measured
by the slope of
the indifference
curve
MRS = -O/A = 8:1
12
10
8
6
4
2
0
1 2 3 4 5
A24
22
20
18
16
14
Apples
Oranges
IC1
MRS = 2:1
MRS = 4:1
MRS = 1:1

11. • MRS changes as x and y change
– reflects the individual’s willingness to trade y for
x
Quantity of x
Quantity of y
x1
y1
y2
x2
U1
At (x1, y1), the indifference curve is steeper.
The person would be willing to give up more
y to gain additional units of x
At (x2, y2), the indifference curve
is flatter. The person would be
willing to give up less y to gain
additional units of x

12. Properties of Indifference Curves
• Higher indifference curves are preferred to lower
ones.
• Indifference curves are downward sloping.
• Indifference curves do not cross.
• Indifference curves are bowed inward or convex
to the origin.
• Indifference curve touches neither X-axis nor Y-
axis.
• Indifference curves are not necessarily parallel to
each other.
• In reality indifference curves are like bangles.

13. 1: Higher indifference curves are
preferred to lower ones.
• Consumers usually prefer more of something
to less of it.
• Higher indifference curves represent larger
quantities of goods than do lower indifference
curves.
More is preferred to Less
Indifference map

14. 2: Indifference curves are downward
sloping.
• A consumer is willing to give up one good only
if he or she gets more of the other good in order
to remain equally happy.
• If the quantity of one good is reduced, the
quantity of the other good must increase.
• For this reason, most indifference curves slope
downward.

15. 3:Indifference curves do not intersect.
Quantityof Pizza
Quantity
of Pepsi
0
C
A
B
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.

16. 1
MRS = 1
8
3
Indifference
curve
A
4: Indifference curves are bowed inward
or convex to the origin.
Quantity
of Pizza
Quantity
of Pepsi
0
14
2
3
7
B
1
MRS = 6
4
6
 People are more willing to
trade away goods that they
have in abundance and less
willing to trade away goods of
which they have little.

17. Perfect Substitutes
X goods0
Y goods
21
4
2
I1
I2
6
3
I3
a straight-line indifference curve of perfect substitutes, marginal
rate of substitution of one good for another remains constant

18. Perfect Complements
Right Shoes0
Left
Shoes
75
7
5 I1
I2
All this means that the two perfect complements are used in a
certain fixed ratio and cannot be substituted for each other.

19. 5. Indifference curve touches neither X-
axis nor Y-axis.
in Figure I1 if it touches X-axis, at M, the consumer will be having OM quantity
of good X and none of Y. Similarly, if an in difference curve I2touches the У-
axis at L the consumer will have only OL of Y good and no amount of X. Such
curves are in contradiction to the assumption that the consumer buys two goods
in combinations.

20. 6. Indifference curves are not necessarily
parallel to each other
The diminishing marginal rate of substitution between the two
goods is essentially not the same in the case of all indifference
schedules. The two curves I1and I2 shown in figure 11 are not
parallel to each other

21. 7. In reality indifference curves are like
bangles
If he increases his consumption of X so as to reach the dotted portion of the
I1 curve horizontally from point S to N he gets negative utility. If to compensate
himself for this loss of utility, he increases the consumption of Y, he may be
again on the dotted portion of the curve, vertically from point S to M. Thus the
consumer may be on the concave portion of the circular curve. Since by moving
to the dotted portion he gets negative utility, the effective region of the circular
curve will be the convex portion.

22. Consumer Equilibrium
 It refers to a situation in which a consumer with given
income and given prices purchases such a combination of
goods which gives him maximum satisfaction and he is not
willing to make any change in it.
 Assumptions:
1) The consumer has a given indifference map exhibiting
his scale of preferences for various combinations of two
goods, X and Y.
2) Fixed amount of money to spend and has to spend
whole of his money on two goods.
3) Prices of goods are given and constant for him. He
cannot influence those prices.
4) Goods are homogeneous and divisible.

24.  There are three indifference curves IC1, IC2 and IC3.
 The price line PT is tangent to the indifference curve
IC2 at point C.
 The consumer gets the maximum satisfaction or is
in equilibrium at point C by purchasing OE units of
good Y and OH units of good X with the given
money income.
 The consumer cannot be in equilibrium at any other
point on indifference curves.
 For instance, point R and S lie on lower indifference
curve IC1 but yield less satisfaction. As regards point
U on indifference curve IC3, the consumer no doubt
gets higher satisfaction but that is outside the
budget line and hence not achievable to the
consumer.

25. Conditions Consumer Equilibrium
 At the equilibrium point, slope of indifference curve =
slope of price line
slope of indifference curve = MRS
slope of price line = PX / PY
Thus, at point J, MRS = PX / PY
 The second order
condition is that indifference
curve must be convex to the
origin at the point of
tangency.

26. FACTORS AFFECTING THE
INDIFFERENCE CURVE
 Prize Effect: the effect due to the price change of one
commodity.
 Income Effect: the effect due to the change in income
of the consumer.
 Substitution Effect: the effect due only to the relative
price change in the commodities.