Indifference Curve Definition
An indifference curve (IC) is a graphical representation of different combinations or consumption bundles of two goods or commodities, providing equal levels of satisfaction and utility for the consumer. In other words, a consumer is considered indifferent between any two bundles indicated by a point on the curve, provided these combinations give the same utility.
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 microeconomicsMicroeconomicsMicroeconomics is a study in economics that involves everyday life, including what we see and experience. It studies individual behavioural patterns, households and corporates and their policies. It deals with supply and demand behaviours in different markets, consumer behaviour, spending patterns, wage-price behaviour, corporate policies., such as consumer and producer equilibrium, measurement of consumer surplusConsumer SurplusConsumer Surplus is the difference between the actual price that the customers pay for a product & the maximum price that they are ready to pay (for a single unit). You can calculate it by, Consumer Surplus = Maximum Price to be paid willingly – Actual Paid Price , theory of exchange, etc.
- An indifference curve is a graphical representation of various combinations or consumption bundles of two commodities. It provides equivalent satisfaction and utility levels for the consumer.
- It makes the consumer indifferent to any of the combinations of goods shown as points on the curve. Also, it means the consumer cannot prefer one bundle over another on the same graph.
- The marginal rate of substitution (MRS) indicates if a consumer is willing to sacrifice one good for another commodity while maintaining the same level of utility.
Understanding Indifference Curve
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.
While each axis denotes a different form of consumer goods, the curve features unique combinations or consumption bundles for any two commodities in points. These combinations provide the same level of satisfaction and utility to the consumer. Since the consumer gets an equal preference for all bundles of goods, they are indifferent about any two combinations on the curve.
The slope of the curve at any given point represents utility for any combination of two goods. When it occurs, it is known as the marginal rate of substitution (MRS). It shows the consumer’s preference for one good over another only if it is equally satisfying.
Indifference Curve Properties
- Downward Slope: In a curve, when the consumption of one commodity increases, the consumption of another decreases for any combination. Since it indicates a positive marginal rate of substitution (MRS), ensuring the same level of satisfaction, it leads to a negative or downward slope.
- Strictly Convex Slope: The curve allows the substitution among two commodities in any combination. As consumption of one good over another gains less utility, the marginal rate of substitution between two goods diminishes. It is visible as a consumer moves along the curve to the right. Hence, it is strictly convex.
- Satisfaction Levels Directly Proportional To Axes Levels: An indifference map is the graphical representation of a group of curves. A curve occurring to the right of an existing one indicates a higher level of consumer satisfaction. And the one on the left shows a lesser consumer satisfaction level. Similarly, the curve at a higher axis level shows greater consumer satisfaction than the curve at a lower axis level. Hence, the consumer always prefers to move upwards in the indifference map.
- Never Intersects Each Other: The set of curves will never intersect each other. The higher level and lower level of curves show different levels of satisfaction. Hence, they do not meet at the point of intersection.
- Never Touches X- and Y-Axes: If a curve touches the horizontal (x-axis) and the vertical (y-axis), it denotes that the assumption of the consumer purchasing two commodities in a combination could be wrong. It shows the consumer’s interest in buying only one good. Hence, the curve never touches x- and y-axes.
How To Analyze Indifference Curve?
An indifference curve reveals many combinations of two goods a consumer prefers to consume. In its analysis, core principles of microeconomics are involved. It comprises individual choices, marginal utilityMarginal UtilityA customer's marginal utility is the satisfaction or benefit derived from one additional unit of product consumed. It could be calculated by dividing the additional utility by the amount of additional units. theory, the subjective theory of value, substitution effects, income, ordinal utility, etc. Marginal rates of substitution and opportunity costsOpportunity CostsThe difference between the chosen plan of action and the next best plan is known as the opportunity cost. It's essentially the cost of the next best alternative that has been forgiven. play a crucial role in the curve analysis. All other variables remain constant.
In the case of any consumer, the utility refers to gain from the consumption of two commodities. Let us consider commodities B1 and B2. In the curve, the quantity consumed by B2 will compensate for the increase in the amount consumed by B2.
If the amount substituted is imperfect, the marginal rate of substitution will be constant. The marginal rate of substitution shows the consumer’s preference for one good over another while maintaining the same level of utility.
Indifference Curve Assumptions
- The consumer is rational to maximize the satisfaction and makes a transitive or consistent choice.
- The consumer is expected to buy any of the two commodities in a combination.
- Consumers can rank a combination of commodities based on their satisfaction levels. Usually, the combination with the higher satisfaction level is preferred.
- The consumer behavior remains constant in the analysis.
- The utility is expressed in terms of ordinal numbers.
- Assumes marginal rate of substitution to diminish.
Jack has 1 unit of cloth and 8 units of the book. He decides to exchange 4 units of books for an additional piece of cloth. The following situations may occur:
- Jack is satisfied with 1 unit of cloth and 8 units of books.
- He is also satisfied with 2 units of cloth and 4 units of books.
In conclusion, Jack has the same level of satisfaction and utility in both situations as a consumer. He can utilize the following combinations based on his choice:
The indifference curve analysis is indicated with a graphical representation. Where the X-axis indicates one commodity (Cloth) and Y-axis refers to another good (Book). Combinations of two goods on the curve provide Jack with the same level of satisfaction (represented by points A, B, C, D in the image).
Indifference Curve and Budget Line
A higher indifference curve shows a higher level of satisfaction. Hence, a consumer prefers to reach the tallest line to attain a higher utility level. But there are some budget constraints due to the low income of the consumer.
If a consumer purchases two goods, the budget limitation can be displayed with the help of a budget line on a graph. A budget line reveals all the possibilities in combinations of two goods a consumer can purchase with limited income. It allows the consumer to buy within a given budget, i.e., within their current income.
The slope of the budget line represents the relative pricing of two commodities. And this indifference in prices defines the opportunity costs. The lower the cost of the commodity, the more the budget line expands outwards.
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.
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.
Frequently Asked Questions (FAQs)
An indifference curve denotes a set of different combinations of two commodities or goods, providing the same level of satisfaction to the consumer. Since all consumption bundles give an equal amount of utility, the consumer is indifferent to all combinations.
One of the properties of the indifference curve is that it is strictly convex and never concave. When the consumer repeatedly substitutes or consumes one good over another, the marginal rate of substitution diminishes. Hence, the curve obtained is always convex.
The indifference curve slopes down from left to right on the graph. It indicates that the slope of the curve is negative. 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.
This has been a guide to What is Indifference Curve and its Definition. Here we discuss the properties of the indifference curve and how to analyze it, along with examples and assumptions. You may also have a look at the following articles to learn more –