In this article we will discuss about:- 1. Meaning and Definitions of Indifference Curves 2. Assumptions of the Indifference Curves 3. Characteristics 4. Budget Line or Price Line 5. Superiority over Utility Analysis 6. Criticisms.
- Meaning and Definitions of Indifference Curves
- Assumptions of the Indifference Curves
- Characteristics of Indifference Curves
- Budget Line or Price Line of Indifference Curves
- Superiority of Indifference Curve Analysis over Utility Analysis
- Criticisms of Indifference Curve Analysis
1. Meaning and Definitions of Indifference Curves:
A curve showing different combinations of two commodities giving the same level of satisfaction is called indifference curve. A consumer is indifferent to these various combinations because the level of satisfaction is the same. On account of indifferent or neutrality of an individual consumer these curves are also called indifference curves.
Different economists have defined indifference curves in different ways.
Some of these definitions are given below:
(1) Prof. Henderson and Prof. Quandt have defined, “The locus of all commodity combinations from which a consumer derives the same level of satisfaction forms an indifference curve.”
(2) Prof. C.E. Ferguson has defined, “An indifference curve is a locus of point—of particular budgets—of combinations of goods—each of which yields the same level of total utility or to which the consumer is indifferent.”
(3) Prof. A.L. Meyers has defined, “An indifference schedule may be defined as a schedule of various combinations of goods that will be equally satisfactory to the individual concerned. If we depict this in the form of a curve, we get an indifference curve.”
(4) According to Prof. A. Kout Soyianmis, “An indifference curve is the locus of points—particular combinations of bundles of goods which yield the same utility (level of satisfaction) to the consumer, so that he is indifferent as to the particular combination he consumes.”
(5) According to Prof. J.M. Joshi, “An indifference curve is a locus of points which are geometrical representations of combination of commodities (X and Y) such that the consumer is indifferent among any of these combinations.”
(6) Prof. J.K. Smith has defined, “It is locus of the points representing pairs of quantities between which the individual is indifferent, so it is termed as indifference curve.”
All the definitions of indifference curve show that they show different combinations of different commodities (X and Y) showing the same level of satisfaction and the consumer has alternatives or he is indifferent to these combinations because the level of satisfaction does not change with the changes in the combinations of these two goods.
In order to understand indifference curve we should understand indifference schedules. An indifference schedule shows different combinations of two commodities (X and Y) showing the same level of satisfaction. Prof. C.R. McConnell and Prof. H.C. Gupta have defined, “An indifference schedule simply shows all various combinations of two products, say A and B, which would yield the same level of total utility of satisfaction to a given consumer.”
An indifference schedule can be seen from the following table:
The above table depicts various combinations of two commodities (X and Y) at which consumer gets same level of satisfaction in the schedule known as indifference schedule. The combinations are A, B, C, D and E.
The units of commodity X increases from 1 to 5 while units of commodity Y decreases from 5 to 1.
When these combinations of two commodities are shown in the form of a diagram we will get a curve known as indifference curve as given below:
The above diagram shows that commodity X is shown on OX- axis while commodity Y on OY-axis. When all the combinations (A, B, C, D, E) of both the commodities are plotted we will get a curve known as indifference curve (IC). It is also called iso-utility curve or equal utility curve.
An individual consumer has different levels of satisfaction with different combinations of two commodities. When all the curves of different levels of satisfaction are shown on a diagram we will get indifference map. Thus, indifference map shows a set of various indifference curves available to an individual consumer.
It can be seen from the following diagram:
The diagram shows four indifference curves showing different combinations of two commodities (X and Y) showing different levels of satisfaction. All the indifference curves to right side of the original indifference curve (IC) show higher levels of satisfaction. In other words, higher the indifference curve higher is the level of satisfaction. It is a scale of preference.
In the diagram the scale of preference of the consumer goes like this IC3 >IC2> IC1> IC. The consumer is not indifferent among the indifference curves as higher indifference curve gives him higher level of satisfaction.
Marginal Rate of Substitution (MRS):
Marginal rate at which change in one commodity in relation to one unit change in the other commodity takes place. MRS is an important tool of indifference curve analysis. It tells the exchange ratio between two commodities when a consumer selects different combinations. The rate at which one commodity is exchanged with other so that the levels of satisfaction remains constant.
The MRS can be understood from the following table:
The Table 2 shows that A combination of X and Y commodities consists of 1 unit of X and 5 units of Y which gives the same level of satisfaction. With the increase in the consumption of X commodity he has to sacrifice y commodity. In combination B he has 1 unit more of X and sacrifices 1 unit of Y and so on and so forth.
It clearly reveals that marginal rate of substitution of commodity X for commodity Y is decreasing. Thus, he possesses more units of commodity X and less of commodity Y but the level of satisfaction remains the same because all the combinations (A, B, C, D and E) are on the same indifference curve.
The modern theory of consumer behaviour is based on the ordinal approach to utility which tells that utility is not measurable in cardinal number but it can be put in order of preference I, II and III based on ordinal numbers. The modern theory of consumer behaviour is also known as the indifference curve approach.
It was propounded by F.Y. Edgeworth, Vilfredo Pareto, R.G.D. Allen and J.R. Hicks. The credit goes to R.G.D. Allen and J.R. Hicks who popularised the theory. The consumer behaviour is studied on the basis of ordinal approach or indifference curve approach or analysis because it has removed the defects of cardinal approach based on utility analysis.
2. Assumptions of the Indifference Curves:
Modern utility theory of consumer behaviour is based on ordinal approach or indifference curve approach.
The theory is based on the following assumptions:
(1) Maximisation of Satisfaction:
The theory is based on the assumption of the maximisation of satisfaction function by each individual consumer with his given income and market prices. He has perfect knowledge of market conditions regarding the availability of goods and their prices.
(2) Ordinal Measurement of Satisfaction:
The approach assumes that satisfaction is measured in ordinal numbers like I, II and III in place of cardinal numbers like 1, 2 and 3. There is scale of preference on the basis of which goods are put in order of preference. Different combinations of commodities showing the same level of satisfaction and different levels of satisfaction are available.
(3) Budget Constraint:
The money income or budget of each consumer is given which is spent on purchasing various goods and services to satisfy his wants. He tries to maximise his satisfaction with this given income or budget constraint.
(4) Diminishing Marginal Rate of Substitution:
The approach assumes that there is diminishing marginal rate of substitution (MRSXY) when a consumer consumes X and Y commodities. The MRSXY is the rate of change in one commodity (Y) in relation to one unit change in the other commodity (X). On account of it the indifference curve shows a diminishing marginal rate of substitution of X for Y (MRSXY).
(5) Satisfaction Depends on the Quantum of Consumption of Commodities:
The approach is based on the assumption that the total satisfaction of an individual consumer depends upon the quantity of commodities consumed by him which can be expressed in the following equation-
Total satisfaction = F (QX1, QX1—————— QXr)
f is the function
QX, QX1 and QXn are the quantities of X, X1, and Xn commodities under consumption.
(6) Static Model:
The ordinal approach to utility analysis is based on the static model of economics. It assumes that goods are divisible into small pieces and there is perfect certainty.
(7) Scale of Preference:
Consumer has scale of preferences under the indifference curve approach or analysis. He has order of preferences, namely, X, Y and Z goods. It means he prefers X first (I), Y second (II), and Z third (III). He ranks in order of preferences like X > Y > Z. It means there is consistency and transitivity in preferences.
3. Characteristics of Indifference Curves:
Indifference curves have the following characteristics:
(1) All the Combinations on an Indifference Curve Give Same Level of Satisfaction:
As we defined, the indifference curve gives same level of satisfaction with different points or combinations of two commodities. A, B, C, D and E combinations, in Diagram 1 clearly shows and clarifies this characteristic of an indifference curve.
(2) A Higher Indifference Curve Shows Higher Level of Satisfaction:
The other characteristic of indifference curve is that higher the indifference curve higher will be the level of satisfaction. It has been shown in Diagram 2 where IC, IC1, IC2 and IC3 four indifference curves show different levels of satisfaction. From the point of level of satisfaction they can be put in this order of preference like IC3 > IC2 > IC1 > IC respectively.
(3) An Indifference Curve Slopes Downward to the Right:
Indifference curves slope downward to the right because consumer has to reduce the consumption of one commodity (Y) if he increases the consumption of commodity X. In order to maintain the same level of satisfaction he has to increase the consumption of commodity X with the decrease in the consumption of commodity Y. It can be seen from the Diagram 3.
Indifference curve will neither be horizontal to OX-axis, nor be vertical to OY-axis and it will not be upward sloping as shown in the Diagram 4.
The Diagram 4(A) shows that the slope of IC is horizontal where he has OY1 of Y commodity only and consumption of X commodity is increasing with given money income. It does not give the same level of satisfaction.
The Diagram 4(B) shows that the consumer is increasing consumption of Y and fixed consumption of X commodity but this combination also not give him same level of satisfaction with the given income.
Diagram 4(C) shows that the consumption of both X and Y commodities is increasing which is not possible with constant income.
Hence, we can say that same level of satisfaction is possible only when an indifference curve slopes downward to the right.
(4) An Indifference Curve is Convex to the Origin:
An indifference curve is convex to the origin because of the application of the principle of diminishing marginal rate of substitution. In order to get same level of satisfaction an individual consumer has to consume more of X commodity and he has to sacrifice more of Y commodity.
MRS is the rate of change in one commodity Y in relation to some unit change in commodity X. The rate of change is decreasing. The MRSXY is decreasing due to operation of the principle of diminishing marginal rate of substitution of X commodity for Y commodity as given in Diagram 5 and the same has been explained in Table 2.
In the diagram ΔY and ΔX show the decrease in commodity Y and increase in commodity X when both are substituted in order to remain on the same level of satisfaction.
(5) Two Indifference Curves do not Intersect Each Other:
Another characteristic of indifference curve is that two indifference curves never intersect each other as they represent different levels of satisfaction. An indifference curve shows the same level of satisfaction.
In the Diagram 6 two indifference curves IC and IC1 have been shown. Before E point IC shows higher level of satisfaction. While after E-point IC2 shows higher level of satisfaction. It is indeterminant. Hence we can say that two indifference curves never intersect each other because they show different levels of satisfaction.
(6) An Indifference Curve neither Touches Horizontal Axis nor Vertical Axis:
Another characteristic of indifference curve is that an indifference curve does not touch OX-axis. If it does so, it means he consumes very large amount of commodity X and zero amount of commodity Y. If the indifference curve touches vertical line (OY-axis) then he will consume a very large quantity of commodity Y while zero quantity of commodity X.
This situation has been shown in Diagram 7 as given below:
The IC touches OY-axis while IC1 touches OX-axis where he consumes very large amount of Y and zero of X while in case of IC1, he has large amount of X commodity while zero amount of Y commodity. But such trends are against the definition of an indifference curve.
(7) Indifference Curves are not Necessarily Parallel to Each Other:
All indifference curves slope downward to right or they have negative slopes.
But the rate of slope may not necessarily be the same as shown in the following diagram:
The diagram shows that IC and IC1 have difference slopes. Hence we can say that the slopes of two indifference curves should not be necessarily parallel to each other.
(8) Perfect Complementary Goods have L-shaped Indifference Curves:
In case of those complementary goods which are jointly demanded like bread and butter, shoes and socks, etc., the indifference curves will be L-shaped as given in Diagram 9.
The diagram depicts that two perfect complementary goods will have L-shaped indifference curves and they will be parallel to OX-axis and OY-axis joining each other at 90°.
4. Budget Line or Price Line of Indifference Curves:
Budget line or price line is an important concept in the indifference curve analysis. It is also known as expenditure line, consumption possibility line, price-income line, etc. Budget line or price line is essential to know the equilibrium of an individual consumer.
Price ratios of two goods and money income of a consumer are shown by a budget line or price line. Thus, budget line or price line shows the various combinations of two commodities that can be purchased by the consumer with his given income. Hence, it tells us the consumer’s budget as well as the relative price ratio.
It can be explained with the help of the following table:
The above table reveals that different combinations, namely, A, B, C, D, E, F of two commodities (X and Y) can be purchased by the consumer with his given income (Rs. 10) as the price of X (Px) is Rs. 2 per unit while price of Y (Py) is Re. 1 per unit. Consumer is free to have any combination from A to F and the level of satisfaction will remain the same. It can be shown in Diagram 10.
In the diagram budget line is AB which shows the different combinations of two commodities which can be purchased by a consumer with his given income as the prices of the goods are known to him. The slope of the budget line (OA/OB) shows the price ratios of two goods (-Px/Py).
Change in Budget Line:
Budget line or price line changes when the price of either commodity x changes or price of commodity Y changes and the level of money income of consumer changes as given in the following diagram-
Diagram 11(A) shows that the price of commodity Y does not change while price of commodity X changes. If we move from O to X we see that the price of X decreases and reverse is the case when we move towards O.
Diagram 11(B) shows that the price of commodity X does not change while price of Y commodity changes. If we move from A to A2 the price of Y commodity decreases while reverse is the case.
Diagram 11(C) shows the change in the money income of the consumer. With the change in income the price or budget lines are drawn parallel to each other. All the lines right to AB price line show higher level of money income of the consumer. If we move reverse from A2 B2 to AB then the money income decreases which shows the lower level of income.
5. Superiority of Indifference Curve Analysis over Utility Analysis:
We have studied cardinal approach on which utility analysis is based along with the ordinal approach which is based on indifference curve analysis. Indifference curve technique is an improvement over the utility analysis propounded by Prof. Alfred Marshall.
The superiority of indifference curve analysis can be explained with the help of the following points:
(1) Based on Ordinal Approach of Utility:
Indifference curve analysis is based on ordinal approach of utility which explains that the preference of a consumer can be put into ordinal numbers like I, II and III. R.G.D. Allen, J.R. Hick, Pareto and other economists have pointed out that utility is a subjective and psychological concept which cannot be measured in cardinal numbers like 1, 2 and 3.
At the same time, the measuring rod of utility is money which is not a stable and exact measurement as we find in case of natural and physical sciences like thermometer, barometer, etc.
In ordinal numbers the combinations of the goods are put in order of preferences and consumer is indifferent to various combinations as they represent the same level of satisfaction. Hence, this method of measuring utility or satisfaction is more practical and realistic.
(2) Marginal Utility of Money does Remain Constant:
Marshallian utility analysis assumes that the marginal utility of money remains constant during the period of transactions. It is unrealistic assumption which is not found in case of indifference curve analysis. Marshallian model is based on single commodity model but in practice a consumer has to consume a variety of goods for the satisfaction of various wants, namely, necessaries, comforts and luxuries.
Indifference curve analysis explains the demand analysis without assuming the marginal utility of money as constant and it is based on multi-commodity model which is more practical and realistic.
(3) Based on Multi-Commodity Combinations:
Indifference curve analysis studies the different combinations of different commodities giving different levels of satisfaction while Marshallian utility analysis deals with different combinations of one commodity only. It takes into consideration different goods including substitutes and complementary goods as well which is more realistic and practical analysis of consumer behaviour.
(4) Segregates Income Effect and Substitution Effect:
Marshallian analysis studies the price effect only and it does not separate income effect and substitution effect from the price effect. In indifference curve analysis we study all these effects, namely, income effect, price effect and substitution effect. It also separates the income effect and substitution effect from the price effect.
When the price of a commodity declines it increases the real income of the consumer which causes income effect and secondly, consumer purchases more of cheaper commodity than the dearer one. It is the substitution effect. Hence the study of all these effects makes the indifference curve analysis more superior to the utility analysis.
(5) More General and Adequate Analysis:
Indifference curve analysis is much more general and adequate analysis than that of Marshallian utility analysis. It is not based on the psychological assumptions, namely, cardinal utility, subjectivity of utility, etc. Whenever there is change in the price of a commodity the effects are divided into two categories, namely, income effect and substitution effect.
The law of demand is widened with the explanation of income effect and substitution effect with the price effect caused by the change in the prices of two commodities. It also studies the effect of prices in case of inferior commodities but Marshallian analysis does not explain it.
(6) Analysis of Income and Welfare Implications with Price Change:
Indifference curve analysis studies the income and welfare effects on account of changes in the prices of goods. When the price of a commodity is reduced the consumer will attain higher level of satisfaction as studied in price effect. It increases the welfare of the consumer.
On the other hand, when the price increases it reduces the real income of consumer and he is in equilibrium at the lower level of satisfaction which has reduced his satisfaction (welfare). Thus, the income and welfare implications can be explained with the help of indifference curves which are not possible in case of Marshallian analysis of consumer behaviour.
(7) Based on Fewer Assumptions:
There is a large number of assumptions on which Marshallian utility curve analysis is based while the indifference analysis is based on fewer assumptions. On account of it the analysis is more realistic and practical. The analysis has been widely accepted and used in all the parts of economics.
6. Criticisms of Indifference Curve Analysis:
There are a variety of uses of indifference curve analysis. It is superior to utility analysis based on cardinal approach. However, the analysis has its limitations.
It has been criticised on various grounds as given below:
(1) Based on Unrealistic Model of Two Goods:
The indifference curve analysis is based on two commodity model. As we see in practice that consumers have unlimited wants and for the satisfaction of their wants they consume more than two goods. The analysis is based on two goods model which is unrealistic and we cannot study more than two goods with the help of the indifference curves. Geometrical technique can study more than two goods and algebra has to be used which is complicated one.
(2) Irrationality of Consumer:
The indifference curve analysis also assumes that each individual consumer is a rational human being and he behaves accordingly. But in real practice we see that consumer is not a rational human being. He is not only affected by economic variable but he is also affected by non-economic variables, namely, climatic condition, region, social custom, caste, language and region while taking the decisions.
(3) Old Wine in a New Bottle:
Indifference curve analysis is nothing but an old wine in a new bottle. It has retained the same assumption of utility analysis as propounded by Marshall. It has given concepts but there is not basic difference between utility analysis and indifference curve analysis. It has taken to ordinal numbers, namely, I, II and III in place of cardinal numbers, namely, 1, 2, and 3. There is no basic difference between the two.
It has taken the diminishing marginal rate of substitution in place of law of diminishing marginal utility (MUx/MUy = MRSxy). It has presented indifference curve analysis in the new form which is just like the utility analysis.
(4) Based on Unrealistic Assumptions:
Indifference curve analysis is based on unrealistic assumptions. It assumes that the consumer is well aware of his preferences or he knows the indifference map. In practice we see that a consumer even does not know the various combinations of two commodities giving the same level of satisfaction. He is not aware of his indifference map.
Sometimes the combinations of two goods are also not realistic which are far from the real practice. For example, 2 pairs of shoes and 4 pairs of shirts or 4 pairs of shoes and 2 pairs of shirts will give the same level of satisfaction. It is not realistic and practical.
(5) Based on Individual Behaviour and Equilibrium:
Indifference curve analysis is based on individual behaviour and equilibrium. It cannot be used to study the group behaviour of consumers and their equilibrium showing the different levels of satisfaction with different combinations of two goods.
(6) Complicated Analysis:
Indifference curve analysis is not an easy analysis. Utility analysis is easy to understand, but indifference curve analysis is complicated one. We cannot segregate income effect and substitution effect from price effect. At the same time, derivation of demand curve with the help of indifference curve is also not an easy task.
(7) Fails to Study Observed Behaviour of the Consumer:
Indifference curve analysis fails to study the observed behaviour of an individual consumer in the market. The collection of data relating to scale of preferences of an individual consumer behaviour are not easily available and their collection is also very difficult. Indifference curves are also imaginary and the consumer behaviour cannot be studied well.
(8) Short Run Study of Consumer’s Preferences:
Indifference curve analysis studies the consumer’s preferences during short period. Consumer’s behaviour goes on changing over a long period of time and it is affected by several factors. This type of study of consumer behaviour is not possible with the help of indifference curve analysis.
Thus, we can say that indifference curve analysis has given a new technique of studying economic analysis and its applications to various parts of economics. It studies consumer behaviour in a different manner than that of Marshallian utility analysis.