What is Indifference Curve? Definition, Properties, Assumptions, Criticism, MRS

These applications make indifference curve concepts valuable for business decision-makers, even if they don’t explicitly use the formal analysis. The theoretical elegance of indifference curves faces several empirical challenges and refinements. This approach avoids the problematic assumption that utility can be measured in absolute terms, focusing instead on relative preferences that can be observed through choices. Indicates that an indifference curve must have a negative slope, or a slope that moves lower on the y-axis. Recall that we are assuming that the tax credit will cause the average fuel economy of US cars to double. So from a consumer behavior perspective, one of the things we want to know in evaluating the policy is whether this improvement in gas mileage will cause an equivalent decrease in the demand for gasoline.

Consumer always prefer more of both commodities, i.e. he always tries to move to a higher indifference curve to get higher and higher satisfaction. Consumer’s preference of 1st bundle as compared to 2nd bundle will be called monotonic preference as 1st bundle contains more of apples, although bananas are same. Consumer’s preference of 1st bundle as compared to 2nd bundle will be called monotonic preference as 1st bundle contains more of both apples and bananas. In the above figure, IC1 and IC2 are two indifference curves, and IC2 is higher than IC1. We can also see that Q is a point on IC2 and S is a point on IC2. We can see that when X1 amount of commodity X was consumed, Y1 amount of commodity Y was also consumed.

Impact of lower price

Therefore, the rate of decrease in a commodity cannot be equal to the rate of increase in another commodity. It is assumed that the consumer has fixed amount of money, all of which is to be spent only on two goods. It is also assumed that prices of both the commodities are constant. Here, f(x) represents a function of good x, which describes the relationship between the quantities of goods x and y that yield the same utility level.

Diminishing marginal utility

As the consumer sacrifices more leisure time for additional income, the MRS decreases because each extra unit of income provides diminishing marginal utility. We know that the marginal utility of consuming a good decreases as its supply increases (see also diminishing marginal utility). Therefore consumers are willing to give up more of this good to get another good of which they have little. If a consumer has a lot of good B, the MRS is 3 units of good B per unit of good A.

Indifference curves and budget lines

• All higher indifference curves, like Uh, will be completely above the budget line and, although the choices on that indifference curve would provide higher utility, they are not affordable given the budget set.
• However, every higher or lower level of satisfaction can be shown on different indifference curves.
• For most consumers, a teaspoon of one salt is always just as good as a teaspoon of the other.
• Graphical representation of indifference curves provides a visual understanding of preferences and trade-offs.

With lower prices, we can now consume at a higher indifference curve of IC2, enabling more bananas and apples. The slope of the budget line represents the relative pricing of two commodities. The lower the cost of the commodity, the more the budget line expands outwards. An indifference curve is a downward sloping convex line connecting the quantity of one good consumed with the amount of another good consumed. Irish-born British economist Francis Ysidro Edgeworth first proposed this two-dimensional graph, also known as the iso-utility curve. If the total satisfaction is to remain the same, the consumer must part with a diminishing number of bananas as he gets as increasing stock of oranges.

Marginal Rate of Substitution (MRS):

• However, there are two extreme scenarios for the shape of an indifference curve.
• A consumer is indifferent to changes in a combination as long as it falls somewhere along the curve.
• This is due to diminishing MRS. The desired rate of commodity Substitute falls as consumer moves along the same indifference curve from left to right.
• Watch the clip from this video carefully to see examples of indifference curves and what makes them useful.

Similarly the combinations shows by points B and E on indifference curve IC1 give equal satisfaction top the consumer. A higher indifference curve that lies above and to the right of another indifference curve represents a higher level of satisfaction and combination on a lower indifference curve yields a lower satisfaction. An Indifference Curve is a graphical representation of different combinations of goods or bundles of goods that provide a consumer the same level of satisfaction. The fourth property entails that indifference curves do not intersect. Intersection would imply inconsistent preferences and contradict the assumption of rational consumer behaviour.

Marginal Rate of Substitution

Imagine an American who does not speak Hindi entering an Indian restaurant where the menu is entirely in Hindi. Without the aid of translation, the customer cannot act as economic theory would predict. 4.10 shows that the highest indifference curve the consumer can reach is IC3 which just touches the con­sumption possibility line AB. Once the consumer reaches this position he will not shift his purchase pattern, unless his income changes or unless the price of X or of Y becomes different. From this reasoning we can conclude that the equili­brium position of the consumer is at the point where the Consumption Possibility Line is the tangent of an Indifference Curve. The Principle of Diminishing Marginal Substitutability corresponds to the older law of diminishing marginal utility.

Delve into the world of business studies and economics with a focus on the properties of indifference curve. This comprehensive exploration provides a detailed understanding of how these factors significantly shape the choices of both consumers and businesses. From basic definitions and applications to intricate analyses of each property, you will be able to appreciate the multifaceted nature of indifference curves. By presenting real-life examples and their implications, this write-up makes understanding these distinct properties both insightful and practical. This properties of indifference curve is an essential read for anyone seeking to enhance their knowledge in managerial economics.

For example, most consumers would probably prefer to eat both sandwiches and burritos during a week and not just one or the other (remember, this is for consumers who consider them both goods—who like them). In fact, if you had only sandwiches to eat for a week, you’d probably be willing to give up a lot of sandwiches for a few burritos and vice versa. If you had reasonably equal amounts of both, you’d be willing to trade one for the other, but at closer to one-to-one ratios. Notice that if we graph this, we naturally get bowed-in indifference curves, as shown in figure 1.4. Preference for variety implies that indifference curves are bowed in.

Transitivity and more is better imply indifference curves do not cross.3. A graph of all the combinations of bundles that a consumer prefers equally. Consumption decisions, such as how much automobile fuel to consume, come fundamentally from our preferences—our likes and dislikes.

Income and Price Changes

This property ensures that economic models remain flexible and realistic. If indifference curves were parallel, it would imply that substitution rates remain constant regardless of consumption levels, which doesn’t match real-world behavior patterns. The non-parallel nature means that the slope of indifference curves changes as we move to different satisfaction levels. This occurs because the ratio at which consumers are willing to substitute between goods depends on how much of each good they already have.