Indifference Curve Analysis SARBJEET KAUR Lecturer in Economics

Contents • • • What is Indifference curve Marginal Rate of Substitutions Properties of IC Budget Constraints Consumer Equilibrium with IC Analysis

• Indifference analysis is an alternative way of explaining consumer choice that does not require an explicit discussion of utility. • Indifferent: the consumer has no preference among the choices. • Indifference curve: a curve showing all the combinations of two goods (or classes of goods) that the consumer is indifferent among.

• The indifference curves are not likely to be vertical, horizontal, or upward sloping. – A vertical or horizontal indifference curve holds the quantity of one of the goods constant, implying that the consumer is indifferent to getting more of one good without giving up any of the other good. – An upward-sloping curve would mean that the consumer is indifferent between a combination of goods that provides less of everything and another that provides more of everything. – Rational consumers usually prefer more to less.

• The slope or steepness of indifference curves is determined by consumer preferences. – It reflects the amount of one good that a consumer must give up to get an additional unit of the other good while remaining equally satisfied. – This relationship changes according to diminishing marginal utility— the more a consumer has of a good, the less the consumer values an additional value of that good. This is shown by an indifference curve that bows in toward the origin.

Indifference Curves: No Crossing Allowed! • Indifference curves cannot cross. • If the curves crossed, it would mean that the same bundle of goods would offer two different levels of satisfaction at the same time. • If we allow that the consumer is indifferent to all points on both curves, then the consumer must not prefer more to less. • There is no way to sort this out. The consumer could not do this and remain a rational consumer

Indifference Map • An indifference map is a complete set of indifference curves. • It indicates the consumer’s preferences among all combinations of goods and services. • The farther from the origin the indifference curve is, the more the combinations of goods along that curve are preferred

Indifference Map

Budget Constraint • The indifference map only reveals the ordering of consumer preferences among bundles of goods. It tells us what the consumer is willing to buy. • It does not tell us what the consumer is able to buy. It does not tell us anything about the consumer’s buying power. • The budget line shows all the combinations of goods that can be purchased with a given level of income

Consumer Equilibrium • The indifference map in combination with the budget line allows us to determine the one combination of goods and services that the consumer most wants and is able to purchase. This is the consumer equilibrium. • The demand curve for a good can be derived from indifference curves and budget lines by changing the price of one of the goods (leaving everything else the same) and finding the equilibrium points.

Consumer Equilibrium

Deriving the Demand Curve