DEFINITION: IC An Indifference curve (IC) is the locus of all those combination of two goods which give the same level of satisfaction to the consumer. Thus consumer is indifferent towards all the combinations lying on the same indifference curve. In other words, consumer gives equal preference to all such combinations.INDIFFERENCE CURVES 24 22f/ @A(1, 22) 20 INDIFFERENCE SCHEDULE 18 (Table Showing Different 46 a Combinations giving Equal wr Satisfaction) 14 e Fe SD) oe Too] os 10 e eS \s A 1 22 Jos Cue B 2 14 | 26 e Cc 3 1o |i4 D 4 Meee E Si iD 8INDIFFERENCE CURVES INDIFFERENCE SCHEDULE > 8 trl ew) |e _ ° Bo a) aMARGINAL RATE OF SUBSTITUTION (MRS)_ The marginal rate of substitution of X for Y (MRS,,) 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. _ Decrease in the Consumption of Y _ 6 AY MRS,,y “ Increase in the Consumption of X AXDIMINISHING MARGINAL RATE OF SUBSTITUTION Combination] Apples | Oranges MRS A 4 22 = B 2 14 8:1 Cc 3) 10 41 D 4 8 2:11 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.LAW OF DIMINISHING MRS 24 22 20 18 16 14 MRS is measured 12 by the slope of 10 the indifference 8 curve Oranges oN AROASSUMPTIONS OF IC ANALYSIS > Rational Consumer > Ordinal Utility » Non-Satiety (More is Preferred to Less) » Diminishing Marginal Rate of Substitution. > Consistency: If a consumer prefer A to B in one period then he will not prefer B to A in another period. > Transitivity: If a consumer prefer A to B and B to C, then he must prefer A to C.PROPERTIES OF IC 1. An Indifference curve has negative slope i.e. it slope downwards from left to right. 2. Indifference curve is always convex to the origin. This implies that two goods are imperfect substitutes and MRS between two goods decreases as a consumer move along an indifference curve. IC will be straight line if MRS is constant and L shaped in case of Complimentary.PROPERTIES OF IC 3. Two Indifference curves never intersect or become tangent to each other. This will violet the rule of Transitivity because: on x IC. Ais equally preferred ie to B and on IC, Ais 14 A equally preferred to C. 4 “ ee 2 This implies Bis equally 26 preferred to C, which can #4 aS not be because more is oF always preferred to less. 12 39 4 6PROPERTIES OF IC 4. Higher indifference curve represents higher satisfaction. Indifference map This is because the 18 combinations lying on higher indifference curve contain more of either one or both goods and more is always preferred to less. lore is preferred to LessPROPERTIES OF IC 5. Indifference curve touches neither X-axis nor Y-axis (By Definition) 6. Indifference curve need not to be parallel to each other (because of Different MRS on different ICs)BUDGET CONSTRAINTS (What is Attainable) Budget constraints limit an individual's ability to consume in light of the prices they must pay for various goods and services. Budget line or Price 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 purchases at the given prices.BUDGET LINE Com | Apples | Oranges | Total binat |(@Rs.6 | @Rs.2_| budget per unit) | Per unit | (RS.)=6xA +2x0 Alo 2 24 B 1 9 24 exler2, 6 24 D| 3 3 24 E 4 0 24 Budget line corresponding to budget of Rs. 24CONSUMER EQUILIBRIUM Consumers choose a combination of goods that will maximize the satisfaction they can achieve, given the limited budget available to them. The maximising combination must satisfy two conditions: = |t must be located on the budget line. = Must give the consumer the most preferred combination of goods and services.CONDITIONS OF CONSUMER EQUILIBRIUM Condition-1: Budget Line should be Tangent to the Indifference Curve. —— Combination A can not be _|attained due to budget constraintsCONDITIONS OF CONSUMER EQUILIBRIUM Point B does not maximize satisfaction because there exist a — point C whichis attainable and > yields a higher satisfaction.CONDITIONS OF CONSUMER EQUILIBRIUM Equilibrium occurs (Point C) when the consumer selects the Combination which reaches the highest attainable indifference curve. At Equilibrium (Point C) we yy would have slope of Indifference Curve (MRSxy) equal to the slope of Budget Line (Px/Py) Ic, Ic, Ic, Ic, Ay Dike 4.5 6 ApplesEFFECT OF CHANGE IN THE BUDGET/INCOME | If budget (Income) of the consumer | increases to Rs. 36, then budget line | will shift outward to L, ase! Ea ae | consumer reduces to Rs. 12, then budget line will shift _, inward to L, prego ofthe beUNDERSTANDING INCOME EFFECT INCOME EFFECT: Effect on the consumer equilibrium caused by change in his income if relative prices remain constant. INCOME CONSUMPTION CURVE (ICC) Curve Showing points of equilibrium at oa various levels of ee consumer income given 6 ; constant product price. 0 ‘ApplesNEGATIVE INCOME EFFECT ICC for Inferior Goods NEGATIVE ICC: in case of inferior goods ICC is negative yl? showing decrease in the © 8 quantity demanded of a good a ; ; ; £6 with the increase in consumer § 5 income. 0SUBSTITUTION EFFECT Substitution Effect refers to change in the amount of goods purchased due to change in their relative prices alone, while real income of the consumer remains constant. The substitution of relatively cheaper good for a relatively expensive good is _ called substitution effect. There are two methods to measure substitution effect (i) Slustky’s Measure and (ii) Hicks Measure.SLUSTKY MEASURE According to Slustky Measure real income is constant if the consumer is left with an income which would enable him to buy his original combination of goods at he new price. Oranges o mM Q A Cc ApplesHICKS MEASURE According to Hicks Constant real income means that consumer will remain on same indifference curve as before the change in price Oranges o M Q HC Appl pples Substitution EffectEFFECT OF CHANGE IN PRICE OF A GOOD ‘Ifprice of Apples increases from Rs. 6 per junit to Rs. 12 per unit, then for a budget of Rs. 24, price line will shift inward to L, 16 14 12 If price of Apples decreases | 40 from Rs. 6 per unittoRs.4 | $8 per unit, then for a budget of = 6 Rs. 24, price line will shift ay outward to L oF Z| et ee J 0 6 ApplesUNDERSTANDING PRICE EFFECT PRICE EFFECT: The price effect may be defined as the change in the consumption of goods when the price of either of the two goods changes while the price of the other good and the income of the consumer remain constant. PRICE CONSUMPTION CURVE (PCC)DECOMPOSITION OF PRICE EFFECT * Price Effect has two components: —the substitution effect; and — the income effect. There are two main methods of decomposition of the price effect into the income and substitution effect : (i) The Hicksian method; and (ii) The Slutsky methodSUMMING UP Indifference curve analysis is an improved technique of Analysing consumer's behaviour. Beside explaining consumer equilibrium and consumer surpluse, indifference curves are useful in the field of Production, Distribution, Exchange, Public Finance and International Trade. But it has a number of questionable assumptions. Accordingly, Samuelson has forwarded the Hypothesis of Revealed Preference to explain consumer behaviour.IMPORTANT QUESTIONS » What is Indifference Curve? Explain Its Main Properties? » Explain income effect and price effect using diagram.? > Define Marginal Rate of Substitution. > What do you understand by term consumer equilibrium? Explain consumer equilibrium with the help of Indifference Curve Technique. > Explain decomposition of price effect into substitution and Income Effect with the help of suitable diagrams.FURTHER READINGS >» M. L. Jhingan, Modern Microeconomics _ Konark Publication, New Delhi. > A. Koutsoyiannis, Modern Micro Economics, McMillan Press, London > Paul Samuelson and Nordhaus: Economics, Tata McGraw Hill Publishing Company, New Delhi. > Boumol, William J and Blinder Alan $ ‘Microeconomics: Principles and Policy’ Thomson, 1* Indian Edition (2007)THANK YOU