Lecture 6 - The Theory of Consumer Behavior: Indifference Curve Approach | Microeconomics- Interaction between individual buyer-seller PDF Download

 Page 1


The Theory of Consumer Behavior: Indifference Curve Approach 
 1 
Institute of Lifelong Learning, University of Delhi 
 
  
 
 
 
 
 
NME – ICT 
Microeconomics 
Lesson: The Theory of Consumer Behavior: Indifference 
Curve Approach 
Lesson Developers: Dr. Jai kishan 
University: Institute of Lifelong Learning, Delhi University  
Reviewer: Bibek Kumar Rajak 
 
 
 
 
 
 
 
Page 2


The Theory of Consumer Behavior: Indifference Curve Approach 
 1 
Institute of Lifelong Learning, University of Delhi 
 
  
 
 
 
 
 
NME – ICT 
Microeconomics 
Lesson: The Theory of Consumer Behavior: Indifference 
Curve Approach 
Lesson Developers: Dr. Jai kishan 
University: Institute of Lifelong Learning, Delhi University  
Reviewer: Bibek Kumar Rajak 
 
 
 
 
 
 
 
The Theory of Consumer Behavior: Indifference Curve Approach 
 2 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
  
Page 3


The Theory of Consumer Behavior: Indifference Curve Approach 
 1 
Institute of Lifelong Learning, University of Delhi 
 
  
 
 
 
 
 
NME – ICT 
Microeconomics 
Lesson: The Theory of Consumer Behavior: Indifference 
Curve Approach 
Lesson Developers: Dr. Jai kishan 
University: Institute of Lifelong Learning, Delhi University  
Reviewer: Bibek Kumar Rajak 
 
 
 
 
 
 
 
The Theory of Consumer Behavior: Indifference Curve Approach 
 2 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
  
The Theory of Consumer Behavior: Indifference Curve Approach 
 3 
Institute of Lifelong Learning, University of Delhi 
 
Table of Contents  
1. Learning Objective  
2. Introduction 
3. Assumptions of Indifference Curve Approach 
4. Indifference Curve: Definition  
5. Indifference Schedule  
6. Indifference Curves Map  
7. Properties of Indifference Curves 
8. Indifference Curve: Special Cases 
9. Budget Line: A Constraint 
10. Consumer’s Equilibrium 
11. Effect of changes in consumer's income on equilibrium (derivation of ICC) 
12. Effect of changes in prices of commodities on equilibrium (derivation of PCC) 
13. Separation of Price Effect (PE) into Income effect (IE) and Substitution effect (SE)  
14. Derivation of demand curve through Indifference Curve Analysis 
15. Conclusion  
16. Exercises 
17. References 
18. MCQs 
 
 
1. Learning Objective: The aim this lesson is to give the readers a comprehensive 
view about; why there is a negative relationship between price and quantity 
demanded and to make them understand the derivation of law of demand and why it 
is not applicable to giffen goods. This lesson will also highlight unusual shapes of 
indifference curves besides the normal one. After learning this you will be able to 
know the consumer equilibrium and price and income effects on it including the 
break-up of price effect in substitution and income effects. 
   
 
 
 
 
 
 
Page 4


The Theory of Consumer Behavior: Indifference Curve Approach 
 1 
Institute of Lifelong Learning, University of Delhi 
 
  
 
 
 
 
 
NME – ICT 
Microeconomics 
Lesson: The Theory of Consumer Behavior: Indifference 
Curve Approach 
Lesson Developers: Dr. Jai kishan 
University: Institute of Lifelong Learning, Delhi University  
Reviewer: Bibek Kumar Rajak 
 
 
 
 
 
 
 
The Theory of Consumer Behavior: Indifference Curve Approach 
 2 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
  
The Theory of Consumer Behavior: Indifference Curve Approach 
 3 
Institute of Lifelong Learning, University of Delhi 
 
Table of Contents  
1. Learning Objective  
2. Introduction 
3. Assumptions of Indifference Curve Approach 
4. Indifference Curve: Definition  
5. Indifference Schedule  
6. Indifference Curves Map  
7. Properties of Indifference Curves 
8. Indifference Curve: Special Cases 
9. Budget Line: A Constraint 
10. Consumer’s Equilibrium 
11. Effect of changes in consumer's income on equilibrium (derivation of ICC) 
12. Effect of changes in prices of commodities on equilibrium (derivation of PCC) 
13. Separation of Price Effect (PE) into Income effect (IE) and Substitution effect (SE)  
14. Derivation of demand curve through Indifference Curve Analysis 
15. Conclusion  
16. Exercises 
17. References 
18. MCQs 
 
 
1. Learning Objective: The aim this lesson is to give the readers a comprehensive 
view about; why there is a negative relationship between price and quantity 
demanded and to make them understand the derivation of law of demand and why it 
is not applicable to giffen goods. This lesson will also highlight unusual shapes of 
indifference curves besides the normal one. After learning this you will be able to 
know the consumer equilibrium and price and income effects on it including the 
break-up of price effect in substitution and income effects. 
   
 
 
 
 
 
 
The Theory of Consumer Behavior: Indifference Curve Approach 
 4 
Institute of Lifelong Learning, University of Delhi 
 
2. Introduction 
This lesson will focus on the ordinal utility approach of consumer behavior; which is 
popularly known as Indifference Curve Analysis. F.Y. Edge worth introduced the concept of 
indifference curve, but J.R. Hicks and R.G.D. Allen popularized it as a theory of consumer 
behavior. It was developed as an alternative theory of consumer behavior, due to increasing 
dissatisfaction with cardinal approach (Marshallian approach) which was based on some 
critical assumptions such as cardinal measurement of utility and constant marginal utility of 
money. These assumptions are neither realistic nor required to establish the point of 
equilibrium or to derive law of demand. 
Did You Know? 
Lets try to understand the difference between cardinal and ordinal measurement of utility by 
a simple example; suppose your friend invite you to his home and offer you Indian meal; 
after consuming the meal your friend ask you to quantify your level of satisfaction in terms 
of money. Likewise, another friend of yours invite you to his home and ask, "Would you like 
to have Indian meal or Chinese meal ". Depending on your preferences you will choose 
Indian meal or Chinese meal. First is the case of cardinal measurement i.e. the Marshallian 
utility approach; whereas second one is the case of ordinal measurement or the indifference 
curve approach.  
This lesson aims to give the reader, a deep insight into the Theory of Consumer Choice. We 
will deals with questions like “How does a consumer decide what to buy?” “What are the 
trade-offs faced by him while making such decisions?” How do the changes in factors like 
prices and, incomes will influence his decision? You will also be able to understand the 
concepts budget constraint, indifference curves and consumer preferences, the effects of 
changes in prices and income will influence the consumer’s equilibrium, income and 
substitution effects, derivation of demand curve with indifference curve. Analysis of 
consumer behavior is a prerequisite to deal with the theory of demand and to establish the 
inverse relationship between price and quantity.   
 3. Assumptions of Indifference Curve Approach 
I. Consumer is Rational: Indifference curve approach assumes that the consumer 
behaves in a rational manner and aims to optimize the level of satisfaction given the income 
and prices. 
Page 5


The Theory of Consumer Behavior: Indifference Curve Approach 
 1 
Institute of Lifelong Learning, University of Delhi 
 
  
 
 
 
 
 
NME – ICT 
Microeconomics 
Lesson: The Theory of Consumer Behavior: Indifference 
Curve Approach 
Lesson Developers: Dr. Jai kishan 
University: Institute of Lifelong Learning, Delhi University  
Reviewer: Bibek Kumar Rajak 
 
 
 
 
 
 
 
The Theory of Consumer Behavior: Indifference Curve Approach 
 2 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
  
The Theory of Consumer Behavior: Indifference Curve Approach 
 3 
Institute of Lifelong Learning, University of Delhi 
 
Table of Contents  
1. Learning Objective  
2. Introduction 
3. Assumptions of Indifference Curve Approach 
4. Indifference Curve: Definition  
5. Indifference Schedule  
6. Indifference Curves Map  
7. Properties of Indifference Curves 
8. Indifference Curve: Special Cases 
9. Budget Line: A Constraint 
10. Consumer’s Equilibrium 
11. Effect of changes in consumer's income on equilibrium (derivation of ICC) 
12. Effect of changes in prices of commodities on equilibrium (derivation of PCC) 
13. Separation of Price Effect (PE) into Income effect (IE) and Substitution effect (SE)  
14. Derivation of demand curve through Indifference Curve Analysis 
15. Conclusion  
16. Exercises 
17. References 
18. MCQs 
 
 
1. Learning Objective: The aim this lesson is to give the readers a comprehensive 
view about; why there is a negative relationship between price and quantity 
demanded and to make them understand the derivation of law of demand and why it 
is not applicable to giffen goods. This lesson will also highlight unusual shapes of 
indifference curves besides the normal one. After learning this you will be able to 
know the consumer equilibrium and price and income effects on it including the 
break-up of price effect in substitution and income effects. 
   
 
 
 
 
 
 
The Theory of Consumer Behavior: Indifference Curve Approach 
 4 
Institute of Lifelong Learning, University of Delhi 
 
2. Introduction 
This lesson will focus on the ordinal utility approach of consumer behavior; which is 
popularly known as Indifference Curve Analysis. F.Y. Edge worth introduced the concept of 
indifference curve, but J.R. Hicks and R.G.D. Allen popularized it as a theory of consumer 
behavior. It was developed as an alternative theory of consumer behavior, due to increasing 
dissatisfaction with cardinal approach (Marshallian approach) which was based on some 
critical assumptions such as cardinal measurement of utility and constant marginal utility of 
money. These assumptions are neither realistic nor required to establish the point of 
equilibrium or to derive law of demand. 
Did You Know? 
Lets try to understand the difference between cardinal and ordinal measurement of utility by 
a simple example; suppose your friend invite you to his home and offer you Indian meal; 
after consuming the meal your friend ask you to quantify your level of satisfaction in terms 
of money. Likewise, another friend of yours invite you to his home and ask, "Would you like 
to have Indian meal or Chinese meal ". Depending on your preferences you will choose 
Indian meal or Chinese meal. First is the case of cardinal measurement i.e. the Marshallian 
utility approach; whereas second one is the case of ordinal measurement or the indifference 
curve approach.  
This lesson aims to give the reader, a deep insight into the Theory of Consumer Choice. We 
will deals with questions like “How does a consumer decide what to buy?” “What are the 
trade-offs faced by him while making such decisions?” How do the changes in factors like 
prices and, incomes will influence his decision? You will also be able to understand the 
concepts budget constraint, indifference curves and consumer preferences, the effects of 
changes in prices and income will influence the consumer’s equilibrium, income and 
substitution effects, derivation of demand curve with indifference curve. Analysis of 
consumer behavior is a prerequisite to deal with the theory of demand and to establish the 
inverse relationship between price and quantity.   
 3. Assumptions of Indifference Curve Approach 
I. Consumer is Rational: Indifference curve approach assumes that the consumer 
behaves in a rational manner and aims to optimize the level of satisfaction given the income 
and prices. 
The Theory of Consumer Behavior: Indifference Curve Approach 
 5 
Institute of Lifelong Learning, University of Delhi 
II. Ordinal Measurement:  The important feature of indifference curve approach is 
Ordinal Measurement of utility. A consumer is assumed to be able to rank the commodities 
according to his preferences; as the specifying the utility of a commodity in cardinal 
numbers as utility is a subjective phenomenon. And it is neither possible nor required to 
measure it in cardinal numbers for establishment of the equilibrium of a consumer. 
III. (A) Consistency of choice: It is assumed that consumer behave in a consistent 
and regular manner so we can be sure about his behavior.  That is if a consumer prefers 
(choose) bundle A (say chocolate ice-cream) to B (say vanilla ice-cream); consumer will not 
choose or prefer B (vanilla ice-cream) over A (chocolate ice-cream) next time when both A 
and B bundles are available. Symbolically, we may express the consistency assumption as 
follows: 
if A>B; then B>A 
III. (B) Transitivity of choice: Besides, it is also assumed that consumer's preferences 
are characterized by transitivity. For example if bundle A (chocolate ice-cream) is preferred 
to B (vanilla ice-cream); and bundle B (vanilla ice-cream) is preferred to C (Kulfi) then we 
can transit automatically that bundle A (chocolate ice-cream) will be preferred to bundle C 
(Kulfi). Therefore; 
If A>B and B>C; then A>C 
IV. Based on Diminishing Marginal Rate of Substitution (DMRS):  Indifference 
curve approach is based on the assumption of diminishing marginal rate of substitution 
(DMRS), which underlines the convexity of indifference curves to the origin. Marginal rate of 
substitution is the rate of exchange/substitution between two commodities X and Y i.e.  
  
  
   
This marginal rate of substitution is also a measure of the slope of indifference curve.  
 
4. Indifference Curve: Definition 
In common parlance indifference is a state of indecisiveness or a situation of not able to 
make a choice. But, in economics, word indifference is used to define a state in which a 
consumer is not bothered to take the decision because; he would be equally beneficial   
whatever may be the outcome. Therefore indifference curve can be defined as: "Indifference 
curve is the locus of points of various combinations of two different commodities which 
yields the same level of satisfaction to the consumer; therefore the consumer is indifferent 
about the choice".