Indifference curve

1. INDIFFERENCE CURVE

2. DEFINITION I ndifference Curve (IC) is graph showing various combinations of two things (usually consumer goods) that yield equal satisfaction or utility to an individual.  The curve is drawn to show the indifferent position of the consumer having the choice of two products to get maximum satisfaction.

3. E xample If there are four points in the graph then they all are satisfying the customer equally.

4. MARGINAL RATE OF SUBSTITUTION (MRS) The gradient of an indifference curve is given by the Marginal Rate of Substitution (MRS). This shows the amount of product A a consumer would be prepared to give up for another unit of B and still maintain the same total utility. The MRS is given by: Marginal Utility of B     =    MU B Marginal Utility of A       MU A i.e . if an additional unit of product B provides twice as much utility as product A then the consumer would sacrifice 2A for 1B.

5. CONSUMER’S EQUILIBRIUM and BUDGET LINE Above diagram explain the process of consumer’s equilibrium . The consumer’s preference scale is described by means of indifference mapping. Then we impose a budget line that reflects our income . Therefore, we can afford only those combinations that are on or inside the price line GH.

6. FOUR IMPORTANT POINTS TO REMEMBER The Marginal Rate of Substitution is of a diminishing nature. The Indifferent Curve is always convex to the origin and thus never makes a straight line. Any point on the curve shows the same level of satisfaction obtained by a consumer, but the different levels of curve represents the different levels of satisfaction. The Indifference Curve can only touch the prize line.

7. FACTORS AFFECTING THE INDIFFERENCE CURVE Prize Effect: the effect due to the price change of one commodity. Income Effect: the effect due to the change in income of the consumer. Substitution Effect: the effect due only to the relative price change in the commodities.

8. PRICE EFFECT When there is no change in the income of the consumer, no change in the price of one commodity, and there is a change in the price of another commodity, there will be a change in the consumption made by the consumer. This change in consumption is known as the Price Effect. Though money income does not increase, the real income increases, generating more purchasing power.

9. INCOME EFFECT Where there is a change in the income of the consumer, but the prices of the commodities remain constant, there will be a change in consumption made by the consumer. This change in consumption is called the Income Effect . Under the income effect there will be a change in the equilibrium position of the consumer and that can be shown in the following diagram.

10. SUBSTITUTIONAL EFFECT When there is a change in the price of one commodity, and when the price of another commodity remains unchanged or constant, the income of the consumer must be changed in such a way that the consumer is neither better off nor worse off. He remains at the same old position. Under that circumstance, if there is a change in the consumption, that would be due to the Substitution Effect.

11. MULTIPLE CHOICE QUESTIONS The Indifference Curve is a graph between: Two different commodities Price vs. quantity Demand vs. supply Want vs ability to pay If there are four points in the graph then they all are satisfying the customer ________. In an increasing order In an decreasing order Equally Randomly

12. MULTIPLE CHOICE QUESTIONS Marginal Rate of Substitution is the ________ of the indifference curve. Mean Slope Peak Inverse MRS= Marginal Utility of B     Marginal Utility of A Marginal Utility of B  *Marginal Utility of A Marginal Utility of A     Marginal Utility of B Marginal Utility of B + Marginal Utility of A

13. MULTIPLE CHOICE QUESTIONS W hich of the following is not true for the indifference curve? The Marginal Rate of Substitution is of a diminishing nature. The Indifferent Curve is always convex to the origin and thus never makes a straight line. The Indifference Curve can only touch the prize line. The points on the curve shows the level of satisfaction obtained by a consumer. Which of the following is not a factor affecting the indifference curve? Income of the consumer Demand and supply of the product Price of the product Difference in the relative price of the products

14. MULTIPLE CHOICE QUESTIONS 7) Which of the following is true for Price Effect? When there is no change in the price of one commodity, and there is a change in the price of another commodity, there will be a change in the consumption made by the consumer. When there is no change in the price of one commodity, and there is no change in the price of another commodity, there will be a change in the consumption made by the consumer. When there is a change in the price of one commodity, and there is a change in the price of another commodity, there will be a change in the consumption made by the consumer. When there is a change in the income of the consumer and no change in the price of one commodities, there will be a change in the consumption made by the consumer.

15. MULTIPLE CHOICE QUESTIONS The graph due to income effect is? b) c) d) all of these

16. MULTIPLE CHOICE QUESTIONS “ the effect due to only the relative price change in the commodities.” refers to? Income effect Substitution effect Price effect None of these A consumer will consume the combination of goods at the point of tangency between the budget line and the indifference curve.(True/False).