Chapter - INDIFFERENCE CURVE - Chapter Notes, Micro Economics, Class 12 - Commerce PDF Download

INDIFFERENCE CURVE / ORDINAL APPROACH

MEANING :: An Indifference curve is a graphical presentation of locus of all such points which shows DIFFERENT COMBINATIONS OF TWO COMMODITIES which GIVES EQUAL SATISFACTION TO THE CONSUMER.

INDIFFERENCE SET :: It is set of combination of two commodities which offer a consumer the same level of satisfaction. So that he is indifference between these combinations.Thus, level of satisfaction of the consumer at point A is the same as at point B, C or D.
Thus these combination together is known as Indifference set

MARGINAL RATE OF SUBSTITUTION :: Marginal rate of substitution refers to that rate at which, in order to get an additional unit of a commodity, the consumer is willing to sacrifice the number of units of another commodity, so that his over-all level of satisfaction may remain unchanged

The SLOPE OF IC IS MRSxy and since MRSxy declines , it makes IC convex curve

CHARACTERISTIC OR PROPERTIES OF INDIFFERENCE CURVES

(1) INDIFFERENCE CURVES SLOPES DOWNWARDS :: In other words, it has a
negative slope. It is so because one good is a substitute of the other and with given income
a consumer has to sacrifice one good to have more of another good .
Thus SUBSTITUTABILITY OF THE GOODS is the reason behind downward slope
of an indifference curve

(2) AN INDIFFERENCE CURVE IS CONVEX TO THE POINT OF ORIGIN ::
This property of indifference curve is based on the LAW OF DIMINISHING MARGINAL RATE
 OF SUBSTITUTION. { As shown in the diagram AB > BC > CD }

WHY MRSXY DECLINES :: As more and more units of Good-X ( apple) are obtained
by the consumer, his intensity of desire for Good-X ( apple) declines . On the other hand, as
more and more units of Good-Y ( orange) are given up, his intensity of desire for Good-Y
( orange) tends to rise.
It is because of this that for every additional unit of Good-X ( apple) , the consumer is willing to give up less and less amount of Good-Y ( orange) .
Accordingly, Y / X i.e MRS xy tends to fall as we move down the IC. and this makes IC convex to the origin.
(3) TWO INDIFFERENCE CURVES NEVER CUT EACH OTHER :: One indifference curve corresponds to a particular level of satisfaction and all points on an indifference curve indicate the same level of satisfaction. If the indifference happen to intersect each other, we shall HAVE A COMMON POINT THAT WOULD INDICATE TWO DIFFERENT LEVELS OF SATISFACTION WHICH IS NOT POSSIBLE.

In the figure IC1 and IC2 happens to intersect at C. We know all points on an indifference curve are
equal to each other, indicating the same level of satisfaction, thus
C= A as on IC1 and
C= B as on IC2 .
which means A on IC1 = B on IC2
This is technically wrong.
However , it DOESNOT MEANS THAT TWO IC’S ARE PARALLEL TO EACH OTHER .
They may or maynot be parallel

(4) HIGHER INDIFFERENCE CURVES REPRESENT MORE
SATISFACTION : Higher indifference curve represents those combinations which yield
more satisfaction than the combinations on the lower indifference curve.
MORE OF BOTH X AND Y GOOD :: Point B on IC₂ represents more units of apples and oranges than point A on IC₁
MORE OF X GOOD WITH SAME Y GOOD :: Point C on IC₂ represents more units of apples and same units of oranges than point A on IC₁
MORE OF Y GOOD WITH SAME X GOOD :: Point D on IC₂ represents more units of oranges and same units of apples than point A on IC₁

INDIFFERENCE MAP :: Indifference map refers to the FAMILY OF INDIFFERENCE CURVES PLACED IN ONE DIAGRAM. It shows a set of indifference curves, one for each level of satisafction.

An indifference which is to the right of the other represents higher level of satisfaction and farther it is from the origin. Thus IC₂ represents higher level of output than IC₁ and IC₃ represents higher level of output compared of both IC₂ and IC₁ . Thus, the higher the INDIFFERENCE curve, the higher the level of SATISFACTION it represents.

PRICE LINE OR BUDGET LINE
 

MEANING :: The budget line SHOWS GRAPHICALLY the different combinations of the
two commodities that a consumer can purchase given
(a) his money income and
(b) price of the two commodities

M = Total income of the consumer
PxQx = Expenditure on good X
PyQy = Expenditure on good Y

Any combination of the amount of the two goods will be called a consumption bundle or
a bundle. (x, y) would mean the bundle consisting of x amount of good X and y amount
of good Y. For example, the bundle (3,4) consists of 3 units of goods X and 4 units of goodY;

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When all these bundles are represented graphically , we get a downward sloping straight
 line known as “BUDGET LINE” OR “PRICE LINE”

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BUDGET SET : It refers to set of all possible combination of the two goods which a
consumer can afford , given his income and prices in the market .
Supposing a consumer has an income of Rs 4 to be spent on apples and oranges. Price of orange is Rs 0.50 per orange and that of apples Rs 1 per apple.

 SLOPE OF PRICE- LINE refers to the price ratios of two goods (apples and oranges)
that is,

“BUDGET LINE” VS BUDGET SET

These are TWO DISTINCT CONCEPTS :

(a) BUDGET SET include ALL THE POSSIBLE BUNDLES which COST LESS THAN OR EQUAL TO CONSUMER’S MONEY INCOME at the given price . On the other hand , budget line represents all those bundles that the consumer can purchase by spending his entire income at the given prices.
(b) the bundles of budget set lie either on or below the budget line . The bundles of budget line lie only on the budget line

(Q) Suppose a consumer wants to consume two goods which are available only in integer units.
The two goods are equally priced at Rs 10 and the consumer’s income is Rs 40.
(i) Write down all the bundles that are available to the consumer.
(ii) Among the bundles that are available to the consumer, identify those which cost her exactly Rs 40.

FEASIBLE REGION { ATTAINABLE COMBINATION }:: A consumer can only
afford to buy combinations that fall along his budget line or inside it. This region is known as feasible region. In other words, the consumer can buy and bundle (x, y) such that

Px Qx + PyQy   M

The inequality is called the consumer’s budget constraint.

(a) If there is any POINT INSIDE OR TO LEFT OF PRICE LINE AB, the consumer will be UNABLE TO SPEND ALL HIS GIVEN INCOME. It is presumed that the consumer spends his entire income on the consumption of these two goods, so AB price line is the limit line of the consumer.
(b) If there is any POINT OUTSIDE OR TO THE RIGHT OF PRICE LINE AB, then the consumer WILL BE UNABLE TO BUY the combinations of two goods because of his limited income This region is called NON-FEASIBLE REGION { NON- ATTAINABLE COMBINATION}

(1) DUE TO CHANGE INCOME OF CONSUMER WITH NO CHANGE IN PRICE OF BOTH GOODS
(1) INCOME INCREASES :: The consumer will be able to purchase more bundles of goods . This will shift the Budget line rightward parallel as shown from AB to A1B1

EXAMPLE :: With increase in income from Rs 4 to Rs 8 , a consumer can have either 8 units of
apple or 16 units of oranges

(2) INCOME DECREASES :: The consumer will not be able to purchase same bundles of
goods and thus this will shift the Budget line leftward parallel as shown from AB to A₂B₂.
NOTE :: This parallel shift is due to no change in price of the goods as the slope of the line
Px / Py ) remains the same

(2) DUE TO CHANGE IN RELATIVE PRICE OF ANY ONE GOODS WITH NO CHANGE IN INCOME OF THE CONSUMER AND NO CHANGE IN PRICE OF ANOTHER GOOD

() CHANGE IN PRICE OF X GOOD
FALL IN PRICE OF X GOODS makes it cheaper and possible for consumer to have more
of it . Thus new budget line is represented by a rightward rotation towards X axis from AB to
AB1 .
RISE IN PRICE OF X GOODS makes it dearer and consumer can only afford less of it .
Thus new budget line is represented by a leftward rotation towards X axis from AB to AB2 .

() CHANGE IN PRICE OF Y GOOD
FALL IN PRICE OF Y GOODS makes it cheaper and possible for consumer to have more
of it . Thus new budget line is represented by a rightward rotation towards Y axis from AB to
A1B .
RISE IN PRICE OF Y GOODS makes it dearer and consumer can only afford less of it .
Thus new budget line is represented by a leftward rotation towards Y axis from AB to A₂B .

CONSUMER’S EQUILIBRIUM - INDIFFERENCE CURVE ANALYSIS
 // ORDINAL APPROACH // HICKS - ALLEN APPROACH

MEANING :: Consumer’s equilibrium refers to a situation where in a consumer gets
MAXIMUM SATISFACTION OUT OF HIS GIVEN INCOME and he has no tendency to make
any change in his existing expenditure.

ASSUMPTIONS ::
(1) Prices of the goods are constant
(2) Consumer’s income is also constant.
(3) Consumer known the price of all thing
(4) Consumer can spend his income in small quantities
(5) Consumer is Rational and so wants to maximises his satisfaction
(6) Consumer is fully aware of the indifference map
(7) Perfect competition in the market and
(8) Goods are divisible

CONDITION OF CONSUMER’S EQUILIBRIUM

KOUTSOYIANNIS “ Two main conditions of consumer’s equilibrium are:
(i) Price line should be TANGENT to the indifference curve i.e and 

(ii) Indifference curve should be CONVEX to the point of origin.” In other words MRS
tends to decline as we move along the IC left to right
PRICE LINE SHOULD BE TANGENT TO INDIFFERENCE CURVE :: Out of C,D and E
combinations, the consumer will be in equilibrium at combination ‘E’ because at this point
price line (AB) is tangent to the highest indifference curve IC₂.
At equilibrium point ‘E’ slope of indifference curve and price line coincide. In other words

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Slope of Indifference curve = Slope of price line MRSxy = Px / Py

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MONOTONIC PREFERENCE :: It means that a rational consumer always prefers more of a commodity as it offers him a higher level of satisfaction.Thus, a consumer’s preferences are monotonic if and only if between any two bundles, the consumer prefers the bundle which has MORE AT LEAST ONE OF THE GOODS AND NO LESS OF THE OTHER GOOD AS COMPARED TO THE OTHER BUNDLE.
 

Example - If a consumer has monotonic preferences, she would prefer the bundle (2, 2)
represented by point F to all the three bundles (1, 1), (2, 1) and (1, 2) as
it has bundle has more of both goods compared to (1, 1);
it has equal amount of good X but more of good Y compared to the bundle (2, 1) and
it has more amount of good X but equal amount good Y compared to the bundle (1, 2)
.Therefore, monotonicity of preferences implies that
Any point above the indifference curve represents a bundle which is preferred to the
bundles on the indifference curve.
Any point below the indifference curve represents a bundles which is inferior to the
bundles on the indifference curve

SIMILARITIES BETWEEN THE TWO APPROACHES

(1) RATIONALITY OF THE CONSUMER :: Both marginal utility analysis and
indifference curve approaches assume that the consumers are rational. Both approaches
assume that the consumers aim at maximising their total satisfaction.
(2) DIMINISHING MARGINAL UTILITY :: Both these theories of demand assume
some form of diminishing marginal utility, i.e., desire for a commodity falls as a consumer
consumes more units of a commodity.
(3) IDENTICAL EQUILIBRIUM CONDITIONS ::

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The two theories are same as Prof. D.H. Robertson believes when he remarks that indifference
 curve analysis is just old wine in a new bottle.

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(4) INTROSPECTIVE METHOD :: Both marginal utility and indifference curve theories use introspective or psychological method to explain consumer’s behaviour. In introspective method, the analysist explains the behaviour of consumers by looking into his own mind.

DIFFERENCE BETWEEN CARDINAL AND ORDINAL APPROACH
 SUPERIORITY OF IC ANALYSIS TO MU ANALYSIS

(1) MEASURABILITY OF UTILITY :: Cardinal approach (MU) assumes measurability of utility
but In Ordinal approach, utility (IC) can be compared but not quantified.
(2) CONSTANT UTILITY OF MONEY :: Cardinal approach assumes constant utility of money, such as an assumption is not made in Ordinal approach.
(3) PRICE EFFECT :: Cardinal approach measures the Price Effect only whereas ordinal approach splits Price Effect into Income Effect and Substitution approach.
(4) INDEPENDENT UTILITY :: Cardinal approach by assuming independent utility, it ignores complementary between goods.This flaw is not present in ordinal approach. as it studies more than one good at a time
(5) GIFFEN GOODS :: Cardinal approach fails to explain the case of Giffen goods but Ordinal approach adequately explains the case of Giffen goods with the help of price effect and income effects.