It is evidenced by figures D, E, and F having decreased marginal utility. Therefore, the principle of diminishing marginal utility indicates that each additional unit of consumption adds less to the cumulative utility than the previous unit. Choice theory formally represents consumers by a preference relation, and use this representation to derive indifference curves showing combinations of equal preference to the consumer. Most economic textbooks build upon indifference curves to introduce the optimal choice of goods for any consumer based on that consumer’s income.
- Therefore both curves can’t provide the same level of satisfaction, which means they can never intersect.
- They are typically represented on a graph with one good on the x-axis and the other good on the y-axis.
- Some economists argue that the concept of indifference is hypothetical and therefore incompatible with real-life economic actions taken by consumers.
- He can improve his position by changing his purchases in such a way as to be on P, which is on a higher indifference curve (IC3).
The higher the indifference curves what are the properties of indifference curve are, the larger the quantities of both goods. The indifference curve slopes down from left to right on the graph. The curve slopes downward as the consumption of commodity A increases in exchange for commodity B. It, thus, maintains the same level of consumer satisfaction in all combinations.
For example, the x-axis may measure the quantity of food available while the y-axis measures the risk involved in obtaining it. The indifference curve is drawn to predict the animal’s behavior at various levels of risk and food availability. Indifference curve analysis emphasizes marginal rates of substitution (MRS) and opportunity costs. It typically assumes that all other variables are constant or stable.
A budget line is derived from a given income and given prices. So any change in income or price leads to a new budget line. Under certain special circumstances an indifference curve may be a straight line or even concave to the origin.
What is Utility?
They represent ‘well-behaved’ preferences, such as more is better and preference for variety. A rational person will prefer a larger quantity of a good than a smaller amount of it. It is assumed that the consumer has not yet reached the satisfaction point in respect of competition of a good. That’s why we go beyond just reporting the news, and delve deep into the concepts and ideas that drive the global economy.
Equilibrium of the Consumer:
The marginal rate of substitution neither increases nor does it remain constant. Like many aspects of contemporary economics, indifference curves have been criticized for oversimplifying or making unrealistic assumptions about human behavior. If we know the budget (or the spending power) of the consumer and his Indifference Map we can find out what quantity of each commodity he will purchase. With the same information we can measure the effect of changes in the prices of commodities and of changes in the income of the consumer. Therefore, the marginal rate of substitution of orange for apple increases as the quantity of orange increases relatively to apple. Alternatively we can say that the marginal rate of substitution of orange for apple diminishes as the supply of apple diminishes.
Indifference Curve and Budget Line
This is called the Principle of Diminishing Marginal Substitutability. It is assumed that the two goods are not perfect substitutes for one another and that want for the goods are not satiable. Let us make an in-depth study of the definition, diagram, assumptions, properties, budget line, equilibrium and analysis of indifference curve.
Although they come in many shapes and sizes, most of them share a few important properties. Thus, we will look at the four most important properties of indifference curves in more detail below. An indifference curve reveals many combinations of two goods a consumer prefers to consume. In its analysis, core principles of microeconomics are involved.
In Figure 4 (C) the indifference curve is shown as vertical and combination В is preferred to A as the consumer has more of Y and the same quantity of X. Therefore, an indifference curve cannot be vertical either. In the above image, the combination outside the budget line (S) represents the one beyond the income. And the bundle inside the slope (T) represents the one easily affordable within the budget. Herbert Hovenkamp (1991)[13] has argued that the presence of an endowment effect has significant implications for law and economics, particularly in regard to welfare economics. Fischel (1995)[15] however, raises the counterpoint that using WTA as a measure of value would deter the development of a nation’s infrastructure and economic growth.
If the marginal rate of substitution had increased, the Indifference Curve would have been concave to the origin. If the marginal rate of substitution had remained constant, the Indifference Curve would have been a diagonal straight line at 45° angle. The marginal do not rate of substitution increases nor does it remain constant. The marginal rate of substitution on the contrary goes on diminishing. So the Indifference Curve has to be convex to the origin of axes. This property of the Indifference Curve is derived from the Law of Diminishing Marginal Rate of Substitution.
In other words, the diminishing marginal rate of substitution between the two goods is essentially not the same in the case of all indifference schedules. The two curves 1; and I2 shown in Figure 8 are not parallel to each other. Alternatively, the slope of the curve indicates the marginal rate of substitution between two goods. When a curve intersects the budget limit of an individual consumer, it creates an optimal consumption bundle. The indifference curve analysis is indicated with a graphical representation.
Indifference Curves are convex (i.e., bowed inward)
Let us consider any two combinations of goods on the same indifference curve, such as (h) and (g). Combination (g) has 1 unit of orange (O) more than combination (h). Hence, when the quantity of one commodity (A) in a combination of two goods increase, the quantity of the other commodity (O) must decline.
It can be assumed, as a rule of rational behaviour, that the consumer will try to secure the maximum possible satisfaction from his income. He will, therefore, be on the highest indifference curve that he can reach with his income. 4.7 we find that in (d), (c), (b) and (a), when consumption of A is reduced from 3 to 2 and 1 unit the consumption of O increases from 2 to 4 and 7.
Preference relations
He may prefer apple to orange but if orange becomes relatively cheap he may be induced to eat a few more units of it. If the price of apple becomes much cheaper he may give up orange altogether. In between two indifference curves there can be a number of other indifference carves, one for every point in the space on the diagram. Since A is on a higher indifference curve and to the right of N, the consumer will be having more of both the goods X and Y.
The indifference curve in economics examines demand patterns for commodity combinations, budget constraints and helps understand customer preferences. The theory applies to welfare economics and microeconomics, such as consumer and producer equilibrium, measurement of consumer surplus, theory of exchange, etc. Indifference curves are a fundamental concept in microeconomics, used to represent consumer preferences and the trade-offs that consumers are willing to make between different goods. In this article, we will provide a comprehensive guide on how to prove the properties of indifference curves, including their key concepts, applications, and significance.