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Table of Contents
1.1 Indifference Curve Analysis
An indifference curve is a curve which represents all those combinations of goods which give same satisfaction (same satisfaction and not money value) to the consumer.
Since all the combinations on an indifference curve give equal satisfaction to the consumer, the consumer is indifferent among them.
1.1.1 Assumptions Underlying Indifference Curve Approach
- The consumer is rational and possesses full information about all the relevant aspects of economic environment in which he lives.
- The consumer is capable of ranking all conceivable combinations of goods according to the satisfaction they yield.
- If the consumer prefers combination A to B, and B to C, then he must prefer combination A to C. In other words, he has consistent consumption pattern behavior.
1.1.2 Marginal rate of substitution
Marginal Rate of Substitution (MRS) is the rate at which the consumer is prepared to exchange one commodity for other. We can also understand MRS as opportunity cost of getting one good by loosing the other.
MRS increases as we loose more of one commodity to get another as initially when you have more of one commodity, you are ready to give up more of it to get another while when you have less of the same commodity, you will be willing to give up less or none of it to get another commodity. (see video for a detailed explanation)
1.1.3 Indifference Map
An Indifference map represents a collection of many indifference curves where each curve represents a certain level of satisfaction.
1.1.4 Properties of Indifference Curve
Indifference curves slope downward to the right: This property implies that when the amount of one good in combination is increased, the amount of the other good is reduced.
Indifference curves are always convex to the origin: Since MRS / opportunity cost generally increases as one moves from one end to other, indifference curves are convex to the origin.
However, there are two extreme situations:
- When two goods are perfect substitutes of each other, the indifference curve is a straight line on which MRS is constant.
- And when two goods are perfect complementary goods (e.g. gasoline and water in a car), the indifference curve will consist of two straight line with a right angle bent which is convex to the origin or in other words, it will be L shaped.
Indifference curves can never intersect each other: No two indifference curves will intersect each other although it is not necessary that they are parallel to each other.
A higher indifference curve represents a higher level of satisfaction than the lower indifference curve: This is because combinations lying on a higher indifference curve contain more of either one or both goods and more goods are preferred to less of them.
Indifference curve will not touch the axis: This is because consumer is choosing between a combination of commodities and wants at least some amount of each commodity rather than none of it.