INDIFFERENCE CURVE

DR MONIKA JAIN
ORDINAL UTILITY
ANALYSIS
The concept of Cardinal Utility was used by Marshal to define
Consumer's Equlibrium. Cardinal Utility means consumer
could measure the satisfaction derived by the
consumption of any goods or services in terms of number
and unit of that measurment is Utils or the Money. 

Where as Ordinal Utility means giving the rank to the utility

dervied by the consimption of goods and services. This
Concept was given by J.R. Hicks. This is more realstic and
better than cardinal utility. This is totally based on
Introspection. 
INDIFFERENCE
CURVE
Indifference curve – A curve that shows combinations of
goods which gives the same level of satisfaction to the
consumers so that an individual is indifferent among the
various combination of goods.
•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.
 INDIFFERENCE CURVES
24
22 A(1, 22)
20
INDIFFERENCE SCHEDULE 18
16 1 4 )
2,
Combination Apples Oranges
14 B( )
1 0
A 1 22 12 3 ,
C(

8)
B 2 14 10

4,

7)
D(
8

5,
C 3 10
Oranges

E(
6
D 4 8
4 IC1
E 5 7 2
0
Apples
1 2 3 4 5
DEFINITION
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.
Indifference schedule is a list of various combinations of
commodities which are equally satisfactory to the consumer
concerned.
ASSUMPTION
 More of a commodity is better than less
 Complete Preferences
 Preference of a consumer are transitive
 Diminishing marginal rate of substitution
PROPERTIES OF
CONSUMER PREFERENCES
More Is Better - all else being the same, more of a
commodity is better than less of it (always wanting more
is known as nonsatiation).
• Good - a commodity for which more is preferred to less, at
least at some levels of consumption
• Bad - something for which less is preferred to more, such as
pollution

© 2009 Pearson Addison-Wesley. All rights reserved.

4-7
MORE OF A COMMODITY IS BETTER THAN
LESS
COMPLETE PREFERENCE
PREFERENCE OF A CONSUMER ARE
TRANSITIVE
MARGINAL RATE OF
SUBSTITUTION
 Marginal rate of substitution – The rate at which
consumer is prepared to exchange goods X and Y is
known as MRS ie the rate at which one good must be
added when the other is taken away in order to keep the
individual indifferent between the two combinations
without changing total satisfaction .
 It is the rate at which a consumer is willing to substitute
one good for another.
MRS
MRS=Y/X
Y = a small change in the quantity of Y
X = a small change in the quantity of 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.
 LAW OF DIMINISHING MRS

24 A
22
20
18
MRS = -O/A = 8:1
16
14 MRS = 4:1
MRS is measured 12 B
by the slope of 10
MRS = 2:1
C
the indifference 8
Oranges

curve 6

D
IC1

E
4
2
0 Apples
1 2 3 4 5
MARGINAL RATE OF
SUBSTITUTION
MRS declines as we move downward to the right along an
indifference curve.

Indifference curves with diminishing MRS are thus convex.

Convexity illustrates that people like variety.

LAW OF DIMINISHING
MARGINAL RATE OF
SUBSTITUTION
Law of diminishing marginal rate of substitution – As you get
more and more of a good X , one is prepared to forego less
and less of Y that is MRS of X for Y diminishes as more and
more of good X is substituted for good Y.
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
An indifference map is a complete set of indifference curves.
It indicates the consumer’s preferences among all
combinations of goods and services
INDIFFERENCE MAP
PROPERTIES OF
INDIFFERENCE
CURVE

• A higher Indifference curves represents a higher satisfaction

• Indifference curves Slopes downward to the right
• Indifference curves cannot intersect each other
• Indifference curves are convex to the origin
PROPERTY 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.
 PROPERTIES OF IC
Higher indifference curve
represents higher satisfaction.

Indifference map

More is preferred to Less

PROPERTY 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.
Ifthe quantity of one good is reduced, the quantity of the
other good must increase.
For this reason, most indifference curves slope downward.
INDIFFERENCE CURVE SHAPES

23
Copyright © Houghton Mifflin Company. All rights reserved.
 PROPERTY 3: INDIFFERENCE CURVES DO
NOT INTERTSECT.

Quantity
of Pepsi

0 Quantity
of Pizza
PROPERTY 4: INDIFFERENCE CURVES ARE CONVEX
TO THE ORIGIN .
 People are more willing to
Quantity
of Pepsi trade away goods that they
14
have in abundance and less
willing to trade away goods of
MRS = 6 which they have little.

8 A
1

4 MRS = 1 B
3 Indifference
1
curve

0 2 3 6 7 Quantity
of Pizza
ODD SPECIAL CASES THAT ARE NOT CONSISTENT WITH THE

PROPERTIES OF INDIFFERENCE CURVE LISTED PREVIOUSLY .

 PERFECT SUBSTITUTES

Nickels

I1 I2 I3
0 1 2 3 Dimes
 PERFECT COMPLEMENTS

Left
Shoes

I2
7
5 I1

0 5 7 Right Shoes
 BUDGET LINE
 Budget line graphically shows the budget constraint.

 The Budget line is the locus of points representing all the

different combinations of the two goods that can be
purchased by the consumer, given his money income and
the prices of the two goods

 The combination of commodities lying to the right of the

budget line are unattainable because the income of the
consumer is not sufficient to be able to buy those
combinations.

 The combination of commodities lying to the left of the

budget line are attainable because the income of the
consumer is sufficient to be able to buy those
combinations
 WHAT IS A BUDGET CONSTRAINT?

 A budget constraint shows the consumer’s purchase

opportunities as every combination of two goods that can
be bought at given prices using a given amount of income.
 The budget constraint measures the combinations of
purchases that a person can afford to make with a given
amount of monetary income.
A BUDGET LINE
30 a

Units of Units of Point on

good X good Y budget line

0 30 a
b
Units of good Y

20 5 20 b
10 10
15 0

10 Assumptions

PX = £2
PY = £1
Budget = £30

0
0 5 10 15 20
Units of good X
EFFECT OF AN INCREASE IN INCOME ON THE BUDGET LINE

40
Assumptions

PX = £2
PY = £1
30
Budget = £40
Units of good Y

n
20
16
m

Budget
10
= £40
Budget
= £30
0
7
0 5 10 15 20
Units of good X
EFFECT ON THE BUDGET LINE OF A FALL IN THE PRICE OF GOOD X
30 a
Assumptions

PX = £1
PY = £1
Budget = £30
Units of good Y

20

10

B1 B2

0
b c
0 5 10 15 20 25 30
Units of good X
 THE BEST FEASIBLE BUNDLE

Tools needed to determine how consumers should allocate

their income between 2 goods :
• Budget Constraint
• Indifference Curves

Consumer’s strategy is to keep moving to higher and higher

indifference curves until he reaches the highest one that is
still affordable.
 HOW TO FIND THE BEST
COMBINATION
Utility is maximized when:
• the indifference curve is just tangent to the budget
line.
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
 THE CONSUMER’S OPTIMUM...

Quantity
of Pepsi

Optimum
B
A

I3
I2
I1
Budget constraint
0 Quantity
of Pizza
 INCOME AND SUBSTITUTION EFFECTS

Income effect – A change in the quantity purchased of

a good by a consumer as result of a change in his
income, prices remaining constant.
Substitution effect – Substitution effect means the
change in the quantity purchased of a good by a
consumer as result of a change in relative prices
alone , real income remaining constant.
INCOME EFFECT: INCOME
CONSUMPTION CURVE

The Income effect means the change in Consumer’s

purchases of the goods as a result of a change in money
income.
Income effect can be either positive or Negative
Income effect is said to be positive when with the increase in
income of the consumer ,his consumption of the good also
increases(Normal Goods)
 Effect on consumption of a change in income
Units of good Y

B1 I1
O
Units of good X
 Effect on consumption of a change in income
Units of good Y

I2
B1 B2 I1
O
Units of good X
 Effect on consumption of a change in income
Units of good Y

I4
I3
I2
B1 B2 B3 B4 I1
O
Units of good X
 Effect on consumption of a change in income
Units of good Y

Income–consumption curve

I4
I3
I2
B1 B2 B3 B4 I1
O
Units of good X
Units of good Y
(normal good)

B1 I1
O
Units of good X
(inferior good)
 b
Units of good Y
(normal good)

I2

B1 I1 B2
O
Units of good X
(inferior good)
 Income–consumption curve

b
Units of good Y
(normal good)

I2

B1 I1 B2
O
Units of good X
(inferior good)
 Consumer Equilibrium under Indifference Curve Analysis

V. Income Effect: Income consumption Curve

a) ICC of Inferior good

The good which is purchased less with the increase in income is

called inferior good.

Rice is
Wheat is inferior
inferior
 Consumer Equilibrium under Indifference Curve Analysis

Income Effect: Income consumption Curve

ICC - good X is
Inferior and
good Y is
Normal

Good
Y

ICC - good Y is
inferior and
good X is
Normal
Good X
INCOME CONSUMPTION CURVE

Thus Income Consumption Curve is the

locus of equilibrium points at various
levels of consumer's income.
EFFECT OF A FALL IN THE PRICE OF GOOD X
30
Assumptions

PX = £2
PY = £1
Budget = £30
Units of good Y

20

10

B1 I1
0
0 5 10 15 20 25 30
Units of good X
EFFECT OF A FALL IN THE PRICE OF GOOD X
30 a
Assumptions

PX = £1
PY = £1
Budget = £30
Units of good Y

20
k

10 I2

B1 I1 B2
0
0 5 10 15 20 25 30
Units of good X
EFFECT OF A FALL IN THE PRICE OF GOOD X
30 a

Price–consumption curve
Units of good Y

20
k

10 I2

B1 I1 B2
0
0 5 10 15 20 25 30
Units of good X
PRICE EFFECT=INCOME
+SUBSTITUTION EFFECTS
A fall in the price of a good has two effects: Substitution &
Income Substitution Effect
• Consumers will tend to buy more of the good that has become
relatively cheaper, and less of the good that is now relatively
more expensive.
• Income Effect
• Consumers experience an increase in real purchasing power
when the price of one good falls
THE ENGEL CURVE
The Engel curve
• Shows the relationship between the quantity of the good
consumed and income

Normal and inferior goods

• Normal goods – upward sloping Engel curve
• Inferior goods – downward sloping Engel curve
ENGEL
Income
CURVES
($ per
month) 30

Engel curve slopes

upward for a
20 normal good.

10

Food (units
0 4 8 12 16 per month)
THE HICKSIAN
METHOD
The new optimum is Eb on I2.
X2 The Total Price Effect is xa to
xb

Eb
Ea I2

I1
xa xb
X1
THE HICKSIAN
METHOD
Draw a line parallel to the new
X2 budget line and tangent to the old
indifference curve

Eb
Ea I2

I1
xa xb
X1
THE HICKSIAN
METHOD
The new optimum on I1 is at Ec. The
X2 movement from Ea to Ec (the increase
in quantity demanded from Xa to Xc) is
solely in response to a change in
relative prices

Eb
Ea I2
Ec I1

xa xc xb
X1
THE HICKSIAN
METHOD
This is the substitution effect.
X2

Eb
Ea I2
Ec
I1

X1
Xa Substitution Effect Xc
THE HICKSIAN
METHOD The remainder of the total effect is due
to a change in real income. The
X2 increase in real income is evidenced
by the movement from I1 to I2

Eb
Ea I2
Ec
I1

X1
Xc Income Effect
Xb
THE HICKSIAN
METHOD
X2

Eb
Ea I2
Ec
I1
xa xc xb
X1
Sub IncomeE
Effect ffect