Consumer Behaviour: Indifference Curve | UGC NET Commerce Preparation Course PDF Download

Indifference Curves

An indifference curve represents a graphical depiction of various combinations of two goods that provide a consumer with the same level of satisfaction or utility. This implies that the consumer is indifferent between these different combinations because they yield equal satisfaction.

Illustration of Indifference Curves:

The images provided depict examples of indifference curves. These graphical representations help us visualize how a consumer can be equally satisfied with different combinations of goods.

Table Plotted as an Indifference Curve:
The table represented as an indifference curve aids in understanding how different quantities of goods can provide the same level of satisfaction to a consumer.

Diminishing marginal utility

The indifference curve is convex due to the principle of diminishing marginal utility. When you have a specific quantity of bananas—enough to satisfy your weekly needs—additional bananas offer minimal satisfaction. As a result, you'd be willing to trade a large number of these extra bananas for a different good that provides more utility.

Indifference Curve Map

An indifference curve map helps us visualize different levels of satisfaction or utility that a consumer derives from various combinations of goods.

We can also illustrate different indifference curves.

All points on curve I2 provide the same level of utility, but this utility is greater than that on indifference curve I1.
Curve I4 represents the highest utility level, which would generally require a higher income compared to I1.

Budget Line

A budget line illustrates the combinations of goods a consumer can purchase with their current income.

For instance, if apples cost £1 and bananas £2, and the budget is £40, the line shows possible combinations like 20 apples and 10 bananas or 10 apples and 15 bananas.

Optimal Consumer Choice

Consumers aim to maximize utility within their budget constraints. This means choosing a combination of goods that provides the highest satisfaction.

• With a budget line of B1, the consumer maximizes utility at the point where the highest indifference curve is tangent to the budget line (20 apples and 10 bananas).
• Given the current income, IC2 is unattainable. IC3 is within reach but offers lower utility compared to the higher IC1.
• The optimal choice of goods can also be illustrated using the Equi-marginal principle.

Income-Consumption Curve

An income-consumption curve reflects how a consumer's consumption pattern changes with variations in income levels.

As income increases, you can afford to reach higher indifference curves, shifting your optimal consumption point to the right. This can be plotted to show how consumption changes with rising income.

Impact of a lower price

When the price of bananas decreases (from £2 to £1.50), you can buy more bananas with the same income. As a result, the budget line shifts to the right.

When prices decrease, consumers can move to a higher indifference curve, such as IC2, allowing for greater consumption of both bananas and apples.

Income and Substitution Effects of a Price Increase

When the price of a good rises, consumers typically buy less due to two primary effects:

1. Income Effect: This effect reflects how a price increase affects consumers' effective income. If the price of a good rises, consumers effectively have less disposable income. For instance, if petrol prices go up, consumers may drive less due to the higher cost, which reduces their overall demand for petrol.

2. Substitution Effect: This effect looks at how a price increase changes the attractiveness of a good relative to alternatives. If petrol prices rise, it becomes relatively cheaper to use public transportation instead, leading to a reduced demand for petrol.

Income and Substitution Effects for a Normal Good

A price increase shifts the budget line inward, meaning you can now afford fewer bananas. The budget line moves from B1 to B2. As a result, consumption drops from point A to point C, reducing the quantity of bananas from Q3 to Q1.

To separate the substitution and income effects, we draw a new budget line parallel to B2 but tangent to the original indifference curve. This parallel line helps isolate the effect of the price change while keeping utility constant (as if income had not changed). The movement from A to B (Q3 to Q2) represents the substitution effect alone.

Income Effect

With a reduced effective income, consumers now operate on a lower indifference curve, such as I2. The change from B to C (Q2 to Q1) reflects the income effect. For a normal good, both the income and substitution effects contribute to a decrease in demand, reinforcing each other.

Effect of a Price Increase for an Inferior Good

For an inferior good, the substitution effect (illustrated by the parallel budget line B-3) causes a significant drop from point A to B. However, the income effect leads to an increase in demand, shifting from Q1 to Q2. Although overall demand may fall, the income effect partially counteracts the substitution effect. This is because a decrease in income leads consumers to purchase more of the inferior good when they can no longer afford more expensive normal or luxury goods.

Giffen Goods

A Giffen good is an exceptional case where the income effect outweighs the substitution effect. This is rare but theoretically possible, such as in a scenario where poor consumers choose between expensive meat and cheap rice. When the price of rice rises, the budget line shifts inward to B2. The resulting income effect is so large that it outweighs the substitution effect, leading to an increase in the quantity of rice consumed (from Q2 to Q3) and a significant drop in meat consumption.