A choice like G is affordable to Lilly, but it lies on indifference curve Ul and thus provides less utility than choice B, which is on indifference curve Um. Economists use the vocabulary of maximizing utility to describe consumer choice. So far in the text, we have described the level of utility that a person receives in numerical terms. This section presents an alternative approach to describing personal preferences, called indifference curve analysis, which avoids the need for using numbers to measure utility.
Both of these combinations would be points on the indifference curve of the young boy. We can see that when X1 amount of commodity X was consumed, Y1 amount of commodity Y was also consumed. When the consumer increased the consumption of commodity X to X2, the amount of commodity Y fell to Y2. And, diminishing marginal rate of substitution states that the rate by which a person substitutes X for Y diminishes more and more with each successive substitution of X for Y. Marginal rate of substitution may be defined as the amount of a commodity that a consumer is willing to trade off for another commodity, as long as the second commodity provides same level of utility as the first one.
- If combination F is equal to combination B in terms of satisfaction and combination E is equal to combination B in satisfaction.
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- Therefore, the principle of diminishing marginal utility indicates that each additional unit of consumption adds less to the cumulative utility than the previous unit.
- Given the combination of Lilly’s personal preferences, as identified by her indifference curves, and Lilly’s opportunity set, which is determined by prices and income, B will be her utility-maximizing choice.
- The indifference curve analysis is indicated with a graphical representation.
Four Properties of Indifference Curves
The slope of an indifference curve, known as the marginal rate of substitution (MRS), represents the rate at which an individual is willing to trade one good for another while maintaining the same level of satisfaction. It indicates the relative importance or preference for one good over the other. The highest achievable indifference curve touches the budget constraint at a single point of tangency. All higher indifference curves, like Uh, will be completely above the budget line and, although the choices on that indifference curve would provide higher utility, they are not affordable given the budget set. All lower indifference curves, like Ul, will cross the budget line in two separate places. When one indifference curve crosses the budget line in two places, however, there will be another, higher, attainable indifference curve sitting above it that touches the budget line at only one point of tangency.
Maximisation of Satisfaction
But as a matter of principle, their ‘effective region’ in the form of segments is shown in Figure 12.9. This is so because indifference curves are assumed to be negatively sloping and convex to the origin. An individual can move to the higher indifference curves and I1 until he reaches the saturation point S where his total utility is the maximum. The convexity rule implies that as the consumer substitutes X for Y, the marginal rate of substitution diminishes. It means that as the amount X is increased by equal amounts that of Y diminish by smaller amounts.
Because of this relationship, the indifference curve is bowed inward (i.e., convex). When more than one curve is represented on a graph showing a different combinations of two different goods on each curve, it is known as an Indifference Map. Each indifference curve on that graph shows one satisfaction level all along the curve. In other what are the properties of indifference curve words, the representation of consumer preferences by a number of indifference curves is known as an indifference map.
Module 6: Utility
Similarly the combinations shows by points B and E on indifference curve IC1 give equal satisfaction top the consumer. In this figure (3.6) as the consumer moves from A to B to C to D, the willingness to substitute good X for good Y diminishes. This means that as the amount of good X is increased by equal amounts, that of good Y diminishes by smaller amounts. The marginal rate of substitution of X for Y is the quantity of Y good that the consumer is willing to give up to gain a marginal unit of good X.
- It is also assumed that prices of both the commodities are constant.
- On a graph, an indifference curve is a link between the combinations of quantities which the consumer regards to yield equal utility.
- (12) The consumer is in a position to order all possible combinations of the two goods.
- It all depends on the marginal rate of substitution on two curves shown in the indifference map.
Perfect Substitutes
In other words, we can say that the combination of goods which lies on a higher indifference curve will be preferred by a consumer to the combination which lies on a lower indifference curve. Here, f(x) represents a function of good x, which describes the relationship between the quantities of goods x and y that yield the same utility level. Different values of c correspond to different indifference curves so we obtain a new curve that’s plotted above and to the right of the previous one if we increase our expected utility.
As indifference curve theory is based on the concept of diminishing marginal rate of substitution, an indifference curve is convex to the origin. On a graph, an indifference curve is a link between the combinations of quantities which the consumer regards to yield equal utility. Simply, an indifference curve is a graphical representation of indifference schedule. If a good satisfies all four properties of indifference curves, the goods are referred to as ordinary goods. The principle of diminishing marginal utility is illustrated here as the total utility increases at a diminishing rate with additional consumption. It is evidenced by figures D, E, and F having decreased marginal utility.
This diminishing marginal rate of substitution gives a convex shape to an indifference curve. The slope of the indifference curve at any point is the negative marginal utility of good A as a proportion of the marginal utility of good B. It indicates that the optimal consumption bundle – the marginal rate of substitution between goods A and B – is the ratio of their prices.
In the curve, the quantity consumed by B2 will compensate for the increase in the amount consumed by B2. It means if a consumer prefers A combination to B combination, and B Combination to C Combination, he will definitely prefer A combination to C combination. Likewise; if a consumer is indifferent towards A and B and he is also indifferent towards Band C, then he will also be indifferent towards A and C. 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 maximize his satisfaction with his given income or budget constraint. Indifference curves have been criticized for oversimplifying or making unrealistic assumptions about human behavior like many aspects of contemporary economics.
That’s why we go beyond just reporting the news, and delve deep into the concepts and ideas that drive the global economy. From macroeconomic theory to the latest innovations in financial technology, we aim to provide our readers with a broad understanding of the forces that shape our world. Moreover, it is only applicable to complementary goods where both the preferred products are not the perfect substitutes of each other. Here, the consumer is assumed to spend on both the products by checking out all the possible combinations deriving the same utility to him. Therefore, no product quantity can be zero, which means the line cannot cut on the axes. Thus, indifference curve is always convex (neither concave nor straight).
Diminishing Marginal Rate of Substitution
It is possible when a consumer is willing to sacrifice some quantity of a good to gain an additional unit of another good. If a consumer is having more of a good without any fall in another good, the consumer will achieve a higher satisfaction level instead of equal. This fall in units of one good to gain more of another good gives a downward slope to the indifference curve. In economics, an indifference curve is a line drawn between different consumption bundles, on a graph charting the quantity of good A consumed versus the quantity of good B consumed.