INDIFFERENCE

CURVE

SAIF-UR-REHMAN
 DEFINITION: IC

An Indifference curve (IC) is the

focus of all those combination of
two goods which give the same
level of satisfaction to the
consumer.

Thus consumer is indifferent towards all the combinations

lying on the same indifference curve. In other words,
consumer gives equal preference to all such
combinations.
 INDIFFERENCE CURVES
24
22 A(1, 22)
20
INDIFFERENCE SCHEDULE 18
(Table Showing Different
16
Combinations giving Equal
Satisfaction) 14
Combinatio Apples Oranges
12
n 10
A 1 22 8
Oranges

6
B 2 14
4
C 3 10 2 Apples
D 4 8 0
E 5 7 1 2 3 4 5 6
 INDIFFERENCE CURVES
24
22 A(1, 22)
20
18
INDIFFERENCE SCHEDULE
16
Combination Apples Oranges 14
A 1 22 12
B 2 14 10
8
C 3 10
Oranges

6
D 4 8
4 IC1
E 5 7 2
0
Apples
1 2 3 4 5
 MARGINAL RATE OF
SUBSTITUTION (MRS)

The marginal rate of substitution of X

for Y (MRSxy) is defined as the
amount of Y, the consumer is just
willing to give up to get one more
unit of X and maintain the same
level of satisfaction.

Decrease in the Consumption of Y = (-) ∆Y

MRSxy =
Increase in the Consumption of X ∆X
 DIMINISHING MARGINAL
RATE OF SUBSTITUTION

Combination Apples Oranges MRS

A 1 22 ---
B 2 14 8:1
C 3 10 4:1
D 4 8 2:1
E 5 7 1:1
As the consumer increases the consumption of
apples, then for getting every additional unit of
apples, he will give up less and less of oranges, that
is, 8:1, 4:1, 2:1, 1:1 respectively This is the Law of
Diminishing MRS.
 LAW OF DIMINISHING MRS

24 A
22
20
18 MRS = -O/A = 8:1
16
14 MRS = 4:1
MRS is measured 12
by the slope of 10 MRS = 2:1
the indifference 8
Oranges

curve 6
4 IC1
2
0 Apples
1 2 3 4 5
 PROPERTIES OF IC

1. An Indifference curve has

negative slope i.e. it slope
downwards from left to right.

2. Indifference curve is always convex to the

origin.
 PROPERTIES OF IC
3. Two Indifference curves
never each other.
 PROPERTIES OF IC
4. Higher indifference curve
represents higher satisfaction.

Indifference map

More is preferred to Less

 PROPERTIES OF IC

5. Indifference curve touches

neither X-axis nor Y-axis.

X
12
10 A(0, 10)
8
Oranges
6
4 IC1
2
Apples
0
1 2 3 4 5
 Budget Line
• A budget line (or, more technically, the budget
constraint ) is a schedule or curve that shows
various combinations of two products a
consumer can purchase with a specific money
income.
 Example:
• If the price of product A is $1.50 and the price of
product B is $1, a consumer could purchase all the
combinations of A and B shown in Table 1 with $12
of money income.
• At one extreme, the consumer might spend all of his or her
income on 8 units of A and have nothing left to spend on B.
Or, by giving up 2 units of A and thereby “freeing” $3, the
consumer could have 6 units of A and 3 of B. And so on to the
other extreme, at which the consumer could buy 12 units of B
at $1 each, spending his or her entire money income on B with
nothing left to spend on A.
• This Figure, shows the same budget line graphically. Note that
the graph is not restricted to whole units of A and B as is the
table. Every point on the graph represents a possible
combination of A and B, including fractional quantities. The
slope of the graphed budget line measures the ratio of the price
of B to the price of A; more precisely, the absolute value of the
𝑃𝑎 $1.00 2
slope is = = . This is the mathematical way of saying
𝑃𝑏 $1.50 3
that the consumer must forgo 2 units of A (measured on the
vertical axis) to buy 3 units of B (measured on the horizontal
axis). In moving down the budget or price line,2 units of A (at
$1.50 each) must be given up to obtain 3 more units of B (at $1
2
each). This yields a slope of .
3
Effect of changes in income of the
consumer on Budget Line
Goods Y

6

4

2

I1 I2 I3

0 1 2 3 Goods X
 The budget line has two other significant
characteristics:

• Effects of Changes in Income

• Effects of Changes in Prices

 Effects of Changes in Income:
• The location of the budget line varies with money income.
• An increase in money income shifts the budget line to the right; a
decrease in money income shifts it to the left.
Changes in Price and Shift in Budget Line

• At the lower price of

X, the given income
purchases OL’ of X
which is greater than
OL.

• At the higher price of

X, the given income
purchases OL” of X
which is less than OL.
Effects of Changes in Prices
 Consumer Equilibrium
• It refers to a situation in which a consumer with given income
and given prices purchases such a combination of goods
which gives him maximum satisfaction and he is not willing to
make any change in it.

• Assumptions:
1) The consumer has a given indifference map exhibiting his
scale of preferences for various combinations of two goods, X
and Y.
2) Fixed amount of money to spend and has to spend whole of
his money on two goods.
3) Prices of goods are given and constant for him. He cannot
influence those prices.
4) Goods are homogeneous and divisible.
• There are three indifference curves IC1, IC2 and IC3.
• The price line PT is tangent to the indifference curve
IC2 at point C.
• The consumer gets the maximum satisfaction or is in
equilibrium at point C by purchasing OE units of good
Y and OH units of good X with the given money
income.

• The consumer cannot be in equilibrium at any other

point on indifference curves.
• For instance, point R and S lie on lower indifference
curve IC1 but yield less satisfaction. As regards point
U on indifference curve IC3, the consumer no doubt
gets higher satisfaction but that is outside the budget
line and hence not achievable to the consumer.
 Conditions

• A given price line must be tangent to an indifference curve or

marginal rate of satisfaction of good X for good Y (MRSxy)
must be equal to the price ratio of the two goods. i.e. MRSxy
= Px / Py

• The second order

condition is that indifference
curve must be convex to the
origin at the point of
tangency.
Income Effect : Income Consumption Curve

• The income effect means the change in consumer’s

preferences of the goods as a result of a change in his
money income.
• Income consumption curve traces out the income effect on
the quantity consumed of the goods.

• Income effect for a good is said to be positive when with

the increase in income of the consumer, his consumption
of good also increases. (Normal Goods)
• Income effect for a good is said to be negative when with
the increase in income of the consumer, his consumption
of good decreases. (Inferior Goods)
Income Consumption Curve
 Continued…
• With the given budget line P1L1, the consumer is
initially in equilibrium at point Q1 on the
indifference curve IC1 and is having OM1 of X and
ON1 of Y.
• As income increases budget line shifts upwards i.e.
from P1L1 to P1L2 to P3L3 and so on.
• With budget line P2L2, equilibrium is at Q2 on IC2.
Similarly it changes with next budget lines.
• If now various points Q1, Q2, Q3 and Q4 showing
consumer’s equilibrium at various levels of income
are joined together, we will gwt Income
Consumption Curve.
Income Consumption Curve in Case of Good X being
Inferior Good
Income Consumption Curve in Case of Good Y being
Inferior Good
Income Consumption Curves of Normal
Goods