The Indifference Curve and It’s Applications

The Indifference Curve and It’s Applications Microeconomics

1. Hamdard University Bangladesh

Assignment On
The Indifference Curve and It’s Applications
Course Name: Microeconomics
Course code: BBA211





Submitted To
Md. Faruk Hossain
Associate Professor
Department of Business Administration
Hamdard University Bangladesh






Submitted By
Imran Hossain
ID: 221221025
Program: BBA (22
nd
Batch)
Department of Business Administration


Date of submission: 7
th
August, 2023

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STUDENT’S DECLARATION

This is Imran Hossain, a student of Bachelor of Business Administration Id no:
(221221025) from Hamdard University Bangladesh hereby declare that this assignment on
“The indifference curve and its application” is uniquely prepared by me.

I am further declaring that; this assignment is only prepared for my academic requirement
and it will not publish in any magazine or journal.

Sincerely yours,











ˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍ
Imran Hossain
ID: 221221025
Department of Business Administration
Faculty of Business Administration
Hamdard University Bangladesh

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LETTER OF TRANSMITTAL


7
th
August, 2023
Md. Faruk Hossain
Associate Professor
Department of Business Administration
Faculty of Business Administration
Hamdard University Bangladesh


Subject: Submission of Assignment.

Dear Sir,

I have completed the assignment on “The indifference curve and its
application”. With due respect, I am submitting my assignment on the above-
mentioned title for the fulfilment of the requirement for the subject
Microeconomics. I requested you to receive the assignment prepared by me on
the basis of my findings. I tried my level best to complete this assignment
properly and to produce meaningful research within all the constraints. All the
supporters and guidelines, I received from you proved very efficient to prepare
the report.


I would like to gratitude you for giving me such a great opportunity to prove my
ability in making a quality assignment. If any mistakes remain, I am heartily
apologized for those. I hope you will take my mistakes with due consideration.


Sincerely yours,

ˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍˍ
Imran Hossain
ID: 221221025
22
nd
Batch
Department of Business Administration
Hamdard University Bangladesh

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TABLE OF CONTENT
Serial
No
Name of Contents Page No
1 Students Declaration 1
2 Letter of Transmittal 2
3 Acknowledgement 4
4 Introduction 5
5 THE Indifference Curve 6
6 Law of Substitution 7
7 The Indifference Map 8
8 Budget Constraint 9
9 The Equilibrium Position of Tangency 10
10 Changes in Income and Price 11,12
11 Deriving The Demand Curve 13
12 Conclusion 14

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ACKNOWLEDGEMENT
To begin with, I would like to thank my associate professor, Md. Faruk Hossain
for providing me with the opportunity to work on this assignment. It helped me
to understand and develop my knowledge about “The Indifference Curve and
its Application”. The work was also made possible with the unconditional
support of my family and friends. Furthermore, I also express my gratitude to
my family and friends for their support and encouragement.

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INTRODUCTION
First and foremost, this assignment with the title “The Indifference Curve and its
Application” it based on chapter 5 is conducted for the purpose of the course
“Microeconomics”. Indifference curve analysis is a fundamental concept in microeconomics
that provides insights into consumer behavior and choice. Indifference curves are constructed
based on the assumption of consumer rationality, where individuals aim to maximize their
satisfaction or utility subject to their budget constraints. These curves are convex to the
origin, reflecting the principle of diminishing marginal rate of substitution, which states that
as a consumer consumes more of one good while keeping the level of satisfaction constant,
the marginal utility derived from those good decreases.

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THE INDIFFERENCE CURVE

An indifference curve is a concept in microeconomics that represents a graphical
representation of different combinations of two goods that provide a consumer with an equal
level of satisfaction or utility. In other words, it shows all the combinations of two goods that
a consumer views as equally preferable or desirable.

For example, A consumer buy different combination of two commodities. And they are pen
and pencil, at a given set of prices. For each combination of two goods, assume that the
consumer prefers one to other or are indifferent between the pair. When asked to choose
between combination of pen of A of 10 unit of pen and 60 units of pencil and combination of
B of 20 units of pen and 40 units of pencil the consumer might (1) prefer A to B (2) prefer B
to A or (3) be indifferent between A and B.

The example of pen and pencil with the table and diagram is given below:

Indifference combination
PEN PENCIL
A 10 60
B 20 40
C 30 25
D 40 20



FIGURE -1: A consumers indifference curve.

Figure-1 shows these combinations diagrammatically. We measure units of pencil on the axis
and units of pen on the other. Each of our four combinations of goods is represented by its
point., A, B, C, D. But these four are by no means the only combinations among which we
are indifferent. Another batch, such as 20 units of pencil and 40 units of pen might be ranked
as equal to A, B, C, D and there are many other not shown. Figure -1 linking up the four
points is an indifferent curve. The points on the curve represents consumption bundles
among which the consumer is indifferent; all are equally desirable.

A
B
C
D
0
10
20
30
40
50
60
70
0 5 10 15 20 25 30 35 40 45
PENCIL
PEN

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LAW OF SUBSTITUTION

The Law of substitution states that the rational consumer should distribute his limited income
among several goods in such a way that the last unit of money spent on each commodity
ensures him the same marginal utility and which is also equal to his marginal utility of
money.

Indifference curve are drowned as bowl-shaped, or convex to the origin. Hence, as we move
downward and to the right along the curve a movement that implies increasing the quantity of
pen and reducing the units of pencil -The curve becomes flatter. The curve is drawn in the
illustrate a property that seems most often to hold true in reality and which we call the law of
substitution.

The scarce a good, the greater its relative substitution value; its marginal utility rises relative
to the marginal utility of the good that has become plentiful.

Thus, in going from A to B in figure-1, we would swap 40 of our 60 pencil units for extra 10
extra pen unit. But from B to C, we would sacrifice only 15 unit of our remaining pencils,
pencil supply to obtain a third pen unit – a1 for 1 swap. For the 40 unit of pen, we would
sacrifice only 20 units from dwindling supply of pencil.

If we join the points A and B of figure-1, we find that the slope of the resulting line
(neglecting its negative sign) has a value of 10; join C and D and the slope of 20. These
figures 30,10, 20 are the substitution rations (sometimes called the marginal rates of
substitution) between the two goods. As the size of the movement along the curve becomes
very small, the closer substitution ratio comes to the actual slope of the difference curve.

The slope of the indifference curve is the measure of the good’s relative marginal utilities, or
of the substitution terms on which foe very small changes the consumer would be willing to
exchange a little less of one good in return for a little more of the other.

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THE INDIFFERENCE MAP

The table in the figure-1 is one of an infinite number of possible tables. We could start with a
more preferred consumption situation and list some of the different combination that would
bring the consumer this higher level of satisfaction. One such table might have begun with 20
pen units and 70 pencil units; another with 30 units of pen units, 80 pencil units. Each table
could be portrayed graphically, each with a corresponding indifference curve.

Figure-2: A Family of Indifference Curves.
Figure-2 shows four such curves; the curve from figure 1 is labeled U3. This diagram is
analogous to a geographic contour map. A person who walks along the path indicated by a
particular height contour on such a map is neither climbing nor descending; similarly, the
consumer who moves from one position to another along a single indifference curve enjoys
neither increasing nor decreasing satisfaction from the change in consumption. Only a few of
the possible indifference curve are shown in figure-2.
Note that as we increasing both goods and thus move in a northeasterly direction across this
map, we are crossing successive indifference curves; hence, we are reaching higher and
higher levels of satisfaction (assuming that the consumer gets greater satisfaction from
receiving increased quantities of both goods). Curve U3 stands for a higher level of
satisfaction than U2; U4 for a higher level of satisfaction than U3; and so forth.
A
B
C
D
U
4
U
2
U
1
0
10
20
30
40
50
60
70
80
0 5 10 15 20 25 30 35 40 45
Pencil
Pen
The Indifference Map

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BUDGET CONSTRAINT
A budget constraint represents all the combinations of goods and services that a consumer
may purchase given current prices within his given income.
Now let a particular consumers indifference map aside for a moment and give the consumer a
fixed income. He has, say, 60 taka per day to spend, and he is confronted with fixed prices for
pizza and burger units – 10.50 for pizza, 10 takas for burger. It is clear that he could spend his
money on any one of a variety of alternative combinations of pizza and burger. At one
extreme, he could buy 40 units of pizza and no burger; at the other 60 burger units and no
pizza. The table with the figure-3 illustrates some of the possible ways in which he could
allocate his 60 takas:

Pizza Burger
M 40 00
30 10.50
20 30
10 40.50
N 0 60


Figure-3: Income Constrains Consumer Spending
Figure-3 plots five of these possibilities. Note that all the points lie on straight line labeled
NM. Moreover, any other attainable point, such as 30 pizza units and 10 burger unit, lies on
MN. The straight budget line MN sums up all the possible combinations of the two goods
M
N
0
10
20
30
40
50
60
70
0 5 10 15 20 25 30 35 40 45
BURGER
PIZZA
A CONSUMER'S BUDGET LINE

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that would just exhaust the consumers income. The slope of MN (neglecting its sign) is
30\
20
which is the ratio of the pizza price to the burger prize. The meaning of the slope is that,
given these prices, every time our consumer gives up 30 burger units, he can gain 20 units of
food. We call NM the consumer’s budget constraint.

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THE EQULIBIRUM POSITION OF TANGENCY
Now we are ready to put our two parts together. The axes of the figure-3 are the same as these
of figure-1 and figure-2. We can superimpose the blue budget line NM upon this line
consumer indifference map, as shown in figure-4. This consumer is free to move anywhere
along NM. Positions to the right and above NM are not allowed because they required more
than 60 takas of income; positions to the left and below NM are irrelevant because the
consumer is assumed to spend the full 60 taka.





Figure-4: Consumer’s Most Preferred and Feasible Consumption Bundle Is Attained at B
We now combine the budget line and indifference contours in one diagram. The consumer
reaches the highest indifference curve attainable with fixed income at point E, which is the
tangency of the budget line with the highest indifference curve. At tangency point E,
substitution ratio equals price ratio PF/PC. This means that all goods marginal utilities are
proportional to their prices, with the marginal utility of the last dollar spent on every good
being equalized.
Budget line just kisses but does not cross an indifference contour, is found the highest utility
contour the consumer can reach.
Geometrically, the consumer is at equilibrium where the slope of the budget line is exactly
equal to the slope of the indifference curve (which is equal to the ratio of the marginal
utilities of the two good).
Consumer equilibrium is attained at the point where the budget line is tangent to the highest
indifference curve. At that point, the consumer’s substitution ratio is just equal to the slope of
the budget line.

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CHANGES IN INCOME AND PRICE
Two important applications of indifference curves are frequently used to consider the effects
of (a) a change in money income and (b) a change in the price of one of the two goods.
A. Income Changes:
Income change refers to a difference or alteration in an individual's or entity's total earnings
or revenue over a specific period of time. It can be positive, indicating an increase in income,
or negative, indicating a decrease in income. Income change can result from various factors,
such as changes in employment status, salary or wage adjustments, fluctuations in business
revenue, investment returns, or any other sources of income.















Figure-5 Effect of Income Change on Equilibrium
An income changes shifts the budget line in a parallel way. Thus, halving income to 30 taka
shifts NM to N’M’, moving equilibrium to B’. (Shows what rising income to 80 takas would
do to equilibrium. Estimate where the new tangency point would come)
Assume, first, that the consumer’s daily income is halved while the two prices remain
unchanged. We could prepare another table, similar to the table for figure-3, showing the new
consumption possibilities. Plotting these points on a diagram such as figure-5, we should find
that the new budget line occupies the position N’ M’ in figure-5. The line has made a parallel
shift inward. The consumer is now free to move only along this new budget line; to maximize
satisfaction, he will move to the highest attainable indifference curve, or to point B’. A
tangency condition for consumer equilibrium applies here as before.

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B. Single Price Change:
A single price change refers to a modification in the price of a particular item, product,
service, or asset. It typically represents the difference between the initial price and the new
price after the adjustment. The change can be an increase or a decrease in price, depending on
the context.

Now return our consumer to his previous daily income of $6, but assume that the price of
pizza rises from 10.50taka to 30 taka while the price of burger is unchanged. Again, we must
examine the change in the budget line. This time we find that it has pivoted on point N and is
now NM, as illustrated in Figure-6. The common sense of such a shift is clear. Since the price
of burger is unchanged, point N is just as available as it was before. But since the price of
pizza has risen, point M (which represents 4 pizza units) is no longer attainable. With pizza
costing 30 taka per unit, only 20 units can now be bought with a daily income of 60 taka. So,
the new budget line still passes through N, but it must pivot at N and pass through M, which
is to the left of M. Equilibrium is now at B, and we have a new tangency point. Higher pizza
price has definitely reduced pizza consumption, but burger consumption may move in either
direction. To clinch your understanding, work out the cases of an increase in income and a
fall in the price of burger or pizza.














Figure-6: Effect of Price Change on Equilibrium
A rise in the price of pizza makes the budget line pivot on N, rotating from NM to NM. The
new tangency equilibrium is at B, where there is definitely less pizza consumed but burger
consumption may either go up or down.

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DERIVING THE DEMAND CURVE
We are now in a position to derive the demand curve. Look carefully at Figure-6. Note that as
we increased the price of pizzafood from 10.50 TAKA per unit to 30 taka per unit, we kept
other things constant. Tastes as represented by the indifference curves did not change, and
money income and the price of burgerclothing stayed constant. Therefore, we are in the
ideal position to trace the demand curve for pizza. At a price of 10.50 taka, the consumer
buys 20 units of pizza, shown as equilibrium point B. When the price rises to 30 taka per unit,
the pizza purchased is 10 unit, at equilibrium point B. If you draw in the budget line
corresponding to a price of 60 taka per unit of pizza, the equilibrium occurs at point B, and
pizza purchases are 0.45 unit. Now plot the price of pizza against the purchases of pizza,
again holding other things constant. You will have derived a neat downward-sloping demand
curve from indifference curves. Note that we have done this without ever needing to mention
the term “utility”—basing the derivation solely on measurable indifference curves.

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CONCLUSION
The concept of indifference curves has proven to be a powerful tool in economics and
decision-making, offering valuable insights into consumer preferences and rational choice
behavior. In conclusion, indifference curves are a crucial tool in economics for understanding
consumer behavior, making optimal consumption choices, and analyzing various economic
phenomena. Their applications extend beyond individual decision-making and have
implications for market behavior, social welfare, and international trade. As economists
continue to refine and expand their use, indifference curves remain a cornerstone in the study
of microeconomics and related fields.
































The End

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