Indifference Curve

Analysis
- Meaning, IC Schedule,
IC Curve, IC Map
(LECTURE-1)
Introduction
- In Utility Analysis, we have read that utility can be
measured in cardinal numbers, But it is not
practical.
- If you drink one cup of tea and one cup of coffee,
you can at the best tell which of the two drinks
gave you more utility, but you cannot express it in
cardinal numbers.
- So, what is meaningful is the ordinal measurement
of utility and indifference curve analysis is based on
this very assumption.
Introduction
- In ordinal measurement system, utility is expressed in
terms of first, second, etc. Ordinal number express the
preference of the consumer for different goods.
- It was in 1881 that British economist Edgeworth first of all
propounded indifference curve analysis in his book
“Mathematical Psychics”.
- The concept was further developed in 1906 by Pareto, in
1913 by W.E. Johnson and in 1915 by Slusky.
- The credit of rendering this analysis as an important tool
of Theory of Demand goes to Hicks and Allen.
- It was discussed in detail by Hicks in his book “Value and
Capital”.
What is an Indifference Curve?

- An Indifference curve is a locus of all such points

which shows different combinations of two
commodities which yield equal satisfaction to the
consumer.
- It means all the points located on an Indifference
curve represent such combinations of two
commodities as yield equal satisfaction to the
consumer.
- Since the combination represented by each point on
the IC yields equal satisfaction, a consumer becomes
indifferent about their choice.
Indifference Curve Schedule
- An Indifference curve schedule refers to a
schedule that indicates different
combinations of two commodities which
yield equal satisfaction.
Combination of Apples Oranges
Apples and
Oranges
A 1 10
B 2 7
C 3 5
D 4 4
 Indifference Curve
- Indifference Curve is a
diagrammatic
representation of
Indifference Schedule.
- Quantity of Apples is shown
on OX-axis and that of
Oranges on OY-axis. IC is
indifference curve.
- Points A,B,C,D on it indicate
combination of Apples and
Oranges.
- This curve also called Iso-
utility curve.
Indifference Map
- In order to indicate higher or
lower levels of satisfaction of
different combinations of
different goods, one makes
use of different IC’s.
- When these different IC’s
are shown in a diagram then
it is called indifference Map.
- The map represents group of
IC which express a given
level of satisfaction.
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Law of Diminishing
Marginal Rate of
Substitution
(LECTURE-2)
What is Marginal Rate of Substitution?

- If the consumer wants his level of satisfaction

may remain same, that is, he wants to remain on
the same IC, he will have to give up some units
of 'Y'-commodity.
- In exchange for the satisfaction obtained from
the additional unit of apple he will have to give
up that many units of oranges whose satisfaction
is equal to the additional satisfaction obtained
from an additional apple.
Explanation
- Prof. Lerner in his book “Economics of
Control” has propounded this law.
According to this law, as a consumer gets
more and more units of X, he will be willing
to give up less and less units of Y.
- Marginal rate of substitution of X for Y will
go on diminishing while the level of
satisfaction of the consumer remains the
same.
 Explanation

Combin Apples Orange MRS

ation s
A 1 10 -

B 2 7 3:1

C 3 5 2:1

D 4 4 1:1
 Why does the MRS diminish?
- Law of diminishing MRS is an extensive form of law of
diminishing MU. According to law of diminishing MU, as a
consumer increases consumption of a good, its MU goes on
diminishing. On contrary, if consumption of good decreases,
its MU increases.
- According to law of diminishing Marginal Utility, MU of
additional apple diminshes and MU of decreasing orange
increases.
- Thus, consumer will be willing to give up less and less units of
oranges for every additional unit of apple.
- This law applies because of i) Particular wants are satisfied ii)
good are imperfect substitutes iii) Goods have alternative
uses.
- The law does not apply to i) Perfect Substitutes ii)
Complementary goods
Constant MRS
- The Marginal rate of Substitution is constant if to obtain
one more unit of X, only one unit of Y is sacificed to
maintain same level of satisfaction.
- In other words rate of Substitution remains constant. The
MRS of perfect Substitutes is constant.

Combin Apples Oranges MRS

ation
A 1 10 -
B 2 9 1:1
C 3 8 1:1
D 4 7 1:1
 Increasing MRS
- The Increasing MRS implies that as the stock of a
commodity increases with the consumer he
substitutes it for other commodity at an increasing
rate to maintain the same level of satisfaction.
- The slope of IC is concave to the origin.
Combin Apples Oranges MRS
ation
A 1 10 -
B 2 9 1:1
C 3 7 2:1
D 4 4 3:1
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Comparison of the Law of
Diminishing Marginal Utility
and the Law of Diminishing
Marginal Rate of
Substitution
(LECTURE-3)
 Comparison of Law of Diminishing
MRS with Dimishing MU
- Law of diminishing Marginal Rate of Substitution and Law of
diminishing Marginal Utility reflect an important tendency of
consumer’s behaviour. According to these laws, as the stock
of a good of a consumer goes on increasing, the Importance
of the additional units of the same goes on diminishing.
- Law of diminishing Marginal Rate of Substitution, therefore,
conforms to the law of diminishing Marginal Utility.
- But according to Prof. Hicks, law of diminishing Marginal Rate
of Substitution explains consumer behaviour with less
assumptions and this law is more realistic.
Comparison

- No need of measuring utility in Cardinal

numbers: Law of diminishing Marginal utility
is based on the unrealistic assumption that
MU can be measured in cardinal numbers.
There is no need of measuring utility in
cardinal numbers in the law of diminishing
marginal rate of Substitution. This law, is
therefore, is more realistic.
Comparison
- No need of independent commodities
assumption: Law of diminishing Marginal utility is
based on the unrealistic assumption that the
utility of commodity depends upon its available
quantity only. For instance, utility of tea is not
influenced by the utility of related good coffee.
In other words, utility of tea is independent of the
utility of coffee. There is no need of such
assumption in the case of law of diminishing
Marginal Rate of Substitution. This law recognises
the inter-dependence of commodities.
Comparison
- No need of constant marginal utility of money:
Law of diminishing Marginal utility assumption
is that the marginal utility of money will remain
constant. Law of diminishing Marginal Rate of
Substitution is free from such assumption.
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Assumptions of The
Indifference Curve
Analysis
(LECTURE-4)
Assumptions

- Rational Consumer: It is assumed that the

consumer will behave rationally. It means the
consumer would like to get maximum
satisfaction out of his total income.
- Ordinal Utility: A consumer can determine his
preferences on the basis of satisfaction
derived from different goods or their
combinations. Utility can be expressed in terms
of ordinal numbers,i.e, first, second etc.
Assumptions

- Diminishing Marginal Rate of Substitution: It

means, as the stock of a commodity
increases with the consumer, he substitutes it
for the other commodity at a diminishing rate.
- Non-Satiety: A consumer does not possess
any good in more than the required quantity.
He does not reach the level of satiety.
Consumer prefers more quantity of a good to
less quantity, i.e. Five rasgullas instead of two
rasgullas.
Assumptions

- Consistency in selection: There is

consistency in consumer’s behaviour. It
means that if at any given time a consumer
prefers A combination of goods to B
combination, then at another time he will not
prefer B combination to A combination.
Assumptions
- Transitivity: This analysis assumes transitivity with
regard to IC and preference. It means if consumer
prefers 'A’ combination to 'B’ combination and 'B’
combination to 'C’ combination. Then he will
definitely prefer 'A’ combination to 'C’ combination.
It consumer is Indifferent towards 'A’ and ‘B’ and he is
also indifferent towards 'B’ and ‘C’, then he will also
be indifferent towards 'A’ and ‘C’.
Assumptions
-Independent Scale of Preference: Another
assumption of IC is that the consumer’s scale of
preference is independent of his income and the
prices of the goods in the market. It means if the
income of the consumer changes or prices of
goods fall or rise in the market, then these changes
will have no effect on the scale of preference of
consumer. It is further assumed that scale of
preference of a consumer is not influenced by
scale of preference of another consumer.
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Properties of
Indifference
Curves
(LECTURE-5)
Properties of Indifference Curves
- An Indifference curve has a negative slope or that it
slopes downwards: An indifference curve slopes
downwards from left to right. In other words, its
slope is negative. This property is based on the
assumption that if a consumer uses more quantity
of the other, then only he will have equal
satisfaction from different combinations.
- If IC does not slope downwards then it can either
be a vertical line, horizontal line or upward sloping
curve.
Properties

- Convex to the point of origin: An IC will

ordinary be convex to the point of origin. This
property of Indifference Curve is based on
law of diminishing Marginal Rate of
Substitution.
- If an IC is not convex, the it can either be a
straight line or concave.
Properties
- Two Indifference
Curves never cut
each other: Each
IC represents
different levels of
satisfaction, so their
intersection is ruled
out.
 Properties
- Higher Indifference Curves
represent more Satisfaction:
In indifference map, higher
IC represents those
combinations which yield
more satisfaction than the
combinations on the lower
IC.
Properties
- Indifference Curve touches neither X-
axis nor Y-axis: It is assumed in the IC
analysis that a consumer buys
combinations of different quantities of
two goods. Hence, an IC touches
neither OX-axis nor OY-axis. In case an
IC touches either axis it means
consumer wants only one commodity
and his demand for another
commodity is zero. An IC may touch
OY-axis then it represents money
instead of commodity.
Properties
- Indifference Curve need
not be parallel to each
other: IC may or may not
be parallel to each other.
It all depends on the
marginal rate of
substitution of two curves
shown in indifference map.
Properties

- Indifference Curves become complex in case of

more than two commodities: When a consumer
desires to have combinations of more than two
commodities, say, three commodities, then we will
have to draw three dimensional IC’s which are
quite complex. If the consumer wants a
combination comprising of more than three goods
then such a combination cannot be expressed in
form of diagram.
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Shape of
Indifference
Curves
(LECTURE-6)
 Shape of Indifference Curves
- Straight Line Indifference curves: If two goods are
perfect Substitutes of each other then there indifference
curve may be a straight line with negative slope. It is so
because marginal rate of Substitution of such goods
remain constant.
- Suppose Taj Mahal and Brooke bond tea are perfect
Substitutes of each other. If in place of 1 kg of Taj Mahal
tea, the consumer buys 1 kg of Brooke bond tea his total
satisfaction remains unchanged. As such,IC of this kind
of goods will not be convex to origin rather it will be a
straight line. MRS of such good is always equal to 1.
Shape of Indifference Curves
- Right-angled Indifference Curves: Marginal
rate of Substitution of prefectly
complementary goods is zero. For example, a
consumer will buy right and left shoes in a
fixed ratio.
- Only one piece of any shoe will not add any
satisfaction to the consumer.
- Thus, perfectly complementary goods have
indifference curves of the shape of right-
angle. MRS of these goods equal to zero.
Price Line (or)
Budget Line
(LECTURE-7)
Price Line or Budget Line
Study of Price line is essential to have the knowledge of
consumer’s equilibrium through indifference curve
analysis. It is also known as Budget line, Consumption
Possibility line, Line of attainable combinations.
In the words of Ferguson, “ The Price Line shows the
combinations of goods that can be purchased if the
entire money income is spent.”
According to Hibdon, “ The budget line shows all the
different combinations of the two commodities that a
consumer can purchase given his money income and
price of two commodities.”
 Price Line or Budget Line
Supposing a consumer has an income of Rs.4 to be
spent on apples and oranges. Price of orange is
Re.0.50 per orange and that of apples is Re.1 per
apple.
Income Apples Oranges
(Rs.) (Re.1) (Re. 0.50)
Four 0 8
Four 1 6
Four 2 4
Four 3 2
Four 4 0
Shifting of Price line
-Due to change in Income: If prices
of the goods remain unchanged,
then with the increase in income,
the price line will shift to the right,
and with a decrease in income it
will shift to the left; its slope
remaining unchanged. In other
words, when price of both goods
remain constant, but income of the
consumer changes, the position of
price line also changes.
- Due to change in Price of one
commodity: If income of
consumer and price of one
commodity remains unchanged,
but the price of other
commodity changes, then the
slope of price line will also
undergo a change.
- When price of apples fall to Re
0.80 per apple while price of
oranges are constant. Slope of
price line will change.
Consumer’s
Equilibrium –
Indifference Curve
Analysis (LECTURE-8)
Consumer’s Equilibrium – IC Analysis
Every consumer aims at getting maximum satisfaction out of
his given expenditure. A consumer may find out with the help
of Indifference Curve Analysis as to how he spend his limited
income on the combination of different goods so that he
may get maximum satisfaction. When a consumer is getting
maximum satisfaction out of his limited income he is said to
be in equilibrium.
Thus, consumer’s equilibrium refers to a situation in which a
consumer with given income and given prices purchases
such a combination of goods and services which gives him
maximum satisfaction and he is not willing to make any
change in it.
Assumptions
- Price of the goods are constant.
- Consumer’s income is also constant.
- Consumer knows the price of all things.
- Consumer can spend his income in small quantities.
- Consumer is rational
- Consumer is fully aware of Indifference map.
- Perfect competition in the market.
- Goods are divisible.
 Conditions of Consumer’s Equilibrium
In the words of Koutsoyiannis, “Two
main conditions of consumer’s
equilibrium are (i) Price line should
be tangent to the indifference
curve, i.e MRS(xy) = P(x)/P(y) and
(ii) Indifference Curve should be
convex to the point of origin.”
(i) Price line should be tangent to
indifference curve: Consumer’s
Equilibrium is the point of tangency
of price line and indifference curve.
Conditions of Consumer’s Equilibrium
- Indifference Curve must be
Convex to the origin: It means
MRS of good-X for good-Y
should be diminishing. It at the
point of equilibrium,
indifference curve is concave
and not convex to the origin,
then it will not be a point of
permanent equilibrium.
Income Effect –
Indifference Curve
Analysis
(LECTURE-9)
Income effect – IC Analysis

The income effect may be defined as the effect on

the purchases of the consumer caused by change
in income, if price remains constant. Income effect
indicated that, other things being equal, increases
in income increases the satisfaction of the
consumer. As a result, equilibrium points shifts
upwards to right. On the contrary, decrease in
income decreases the satisfaction of the consumer
and his equilibrium point shifts downwards to the
left.
Classification of goods
(1) Normal goods: The goods whose income effect is positive
but price effect is negative are called normal goods.
(i) Positive: Positive income effect means that demand
increases with increase in income and decreases with
decrease in income. Thus, the income-demand curve
slopes upwards.
(ii) Negative: Negative price effect means that demand
contracts with rise in price and extends with fall in price.
Thus, demand curve slopes downwards. Most of the
goods consumed by the consumers are normal goods.
Classification of Goods
(2) Inferior Goods: Those goods whose income
effect and price effect are negative are called
inferior goods.
(i) Negative: Negative income effect means that
demand contracts with increase in income and
extends with decrease in income.
(ii) Negative: Negative price effect means that
demand contracts with rise in price and extends
with fall in price. As such, demand curve slopes
downwards, as in case of normal goods.
Classification of goods
(3) Giffen’s Goods: In fact, Giffen’s goods are a kind of inferior goods.
Sir Robert Giffen was the first scholar who made a mention of these
goods. That is the reason why these are called Giffen’s goods. Those
goods whose income effect is negative, but price effect is positive,
are called Giffen’s goods.
(i) Negative: Income effect of Giffen’s goods in negative as in case
of inferior goods. In other words, their demand falls with increase
in income and rises with decrease in income.
(ii) Positive: Price effect of Giffen’s goods slopes upward. Those
goods are exceptions to the law of demand. These, are known
as Giffen’s Paradox.
All Giffen goods are inferior goods, but all inferior goods are not
giffen goods.
Income
Consumption
Curve
(LECTURE-10)
Income Consumption Curve

Effect of change in income is reflected in income

consumption curve (ICC), This curve is a locus of
tangency points of price-lines and indifference
curves.
Income Consumption Curve refers to the effect of
change in income on the equilibrium of the
consumer.
Slope of ICC is positive in case of normal goods, but
negative in case of Inferior Goods.
Positive Slope
Income consumption curve is positive
in case of normal goods. In other
words, consumption of both normal
goods ‘X and Y’ increases with
increase in income.
ICC indicates that expenditure on
both the goods will increase in same
ratio
ICC1 indicates more proportionate
increase in expenditure of good-X
ICC2 indicates more proportionate
increase in expenditure of good-Y
Negative Slope
Income effect of inferior goods is negative. It
means inferior goods are bought in less
quantity when income of consumer increases.
Suppose X-good is inferior and good-Y is
normal.
Price line AB, drawn on basis of given income
of consumer and price of two commodities
touches IC1 at point E which is point of
consumer Equilibrium.
As income of consumer goes on increasing,
Price line shifts to right as CD and EF touching
IC2 and IC3 at point E1 and E2. Thus, quantity
of good X decreases. This decreased demand
reflects negative income effect. By joining
equilibrium points we get ICC that slopes
backward to left.
ICC1 curve shows, If good-Y is
an inferior good. Curve turns
downwards after point 'A’
meaning thereby that less of
good-Y will be bought when
income increases. ICC2 curve
shows that good X is an
inferior good. This curve turns
backward after point ‘B’
meaning thereby that less of
good X be bought when
income of consumer
increases.
Engel’s Curve
(LESSON-11)
Engel’s Curve
Eminent German scholar Ernest Engel put forward
Engel Curve. “An Engel curve is a locus of points
relating to equilibrium quantity of same good and
level of money income.”
In other words, Engel curve indicates how much
quantity of a commodity a consumer will consume
at different levels of his income in order to be in
equilibrium.
Engel’s curve can be drawn with the help of
income consumption curve.
Graph
Quantity of X-commodity has
been shown on OX-axis and
income has been shown on OY-
axis. At I1 level of income, OQ1
quantity of X-commodity is
demanded and at I2 level of
income, OQ2 quantity will be
demanded. Point A and B
represent levels of consumer’s
equilibrium. By joining these
points one get EE curve. Slope
of Engel’s Curve depend on
nature of commodity.
Substitution Effect –
Indifference Curve
Analysis
(LECTURE-12)

By: Kanika Bajaj

Substitution Effect
If with change in the prices of the goods the money
income of the consumer changes in such a way
that his real income remains constant, then the
consumer will substitute cheaper good for the
dearer good. Then, it will effect the quantity
purchased of both the goods. This effect is known as
Substitution Effect.
Substutution Effect refers to change in the amount
of goods purchased due to change in their relative
prices alone, while real income of the consumer
remains the same.
Supposing the income of the consumer is Rs.4 that he
spends on the purchase of oranges and apples. Price of
Oranges is 50 paise per orange and price of apples is Re.
1 per apple. With this income he buys 4 oranges and 2
apples and finds himself in equilibrium.
When the price of apple falls to 50 paise per apple, price
of oranges remaining the same, then the consumer can
buy same quantity of oranges and applee at just Rs.3
only. It means consumer is left with one rupee after the
above purchase. In other words, consumer’s real income
has gone up.
If one rupee is taken away from the consumer, his real income will
remain the same i.e., he will continue to buy with Rs. 3 only, 4
oranges and 2 apples as before.
But relative price of apples being less, a rational consumer would
like to substitute apples for oranges. He may buy with an income of
Rs. 3 only; 2 oranges and 4 apples (instead of 4 oranges and 2
apples). This substitution made by the consumer of relatively
cheaper good (in this case apples) for a relatively dearer good (in
this case oranges) is called Substitution Effect.
Thus, Substitution effect means those changes in the quantities of
goods bought which arise due to change in their relative prices
while the real income of the consumer remains constant.
Consumer Satisfaction
neither increases nor
decreases, or he is
neither better off nor
worse off. His level of
satisfaction remains the
same as before. In other
words, he remains on
the same old IC.
Substitution Effect makes
no change in the level
of satisfaction.
Price Effect –
Indifference
Curve Analysis
(LECTURE-13)

By: Kanika Bajaj

Price Effect
Price effect means change in the consumption of
goods when the price of either of the two goods
changes, while the price of the other good and
the income of the consumer remain same.
In the words of Lipsey, “The price effect shows how
much satisfaction of the consumer varies due to
the change in the consumption of two goods as
the price of one changes the price of other and
money income remains constant.”
Price Effect
Suppose the income of the
consumer remains constant at Rs.
4 and price of oranges also
remains same at 50 paise per
orange, but price of apple
fluctuates around Re.1 per apple.
Effect of change in price of
apples, price of one of the
goods, on consumer’s equilibrium
is called price effect. By joining
different equilibrium points one
get price consumption curve.
Price Consumption Curve
The Price Consumption Curve for commodity X is the locus of points of
consumer’s equilibrium when only the price of 'X’ is varied, the price of
'Y’ and income of the consumer remaining constant.
PCC can have different slopes.
(a) If PCC is a downward sloping curve from left to right, then 'x’ and 'y’
goods will be substitutes of one another.
(b) If PCC is a horizontal line parallel to OX-axis, then 'x’ and 'y’ will be
unrelated goods.
(c) If PCC is an upward sloping curve from left to right the 'x’ and 'y’
goods will be complementary to each other.
(d) If PCC is a backward sloping curve then 'x’ good will be giffen good
and 'y’ good a normal good.
(e) If PCC is a vertical line parallel to OY-axis, then 'x’ good will be an
inferior good.
Price Effect is a combination
of Substitution effect &
Income effect
(LECTURE-14)

By: Kanika Bajaj

PE = SE + IE
We know that when the price of a commodity
changes, it has two effects:
(1) There is a change in the real income of the
consumer leading to change in consumption. It
is called income effect.
(2) Due to change in relative price,the consumer
substitutes relatively cheaper good for relatively
dearer good. It is called substutution effect.
The combination of this income and substitution
effect is called Price Effect.
Graph
AB is original price line. When
price of apples falls then the
new price line shifts from AB to
AC. This shows price effect.
Fall in price of apples means
increase in real income of
consumer. If monetary income
of consumer is reduced such
that his real income remain
unchages then new price line
will be PH. Movement from E to
E2 shows Substitution Effect.
If with fall in income,the money
income of consumer is not
reduced, then movement from
E2 to E1 shows income effect.
Substitution effect is always negative, that rise in the
relative price of a good its demand will fall and with fall in
the relative price of good its demand will rise. Income
effect of change in the price of normal good is also
negative. It means that due to rise in price of good,
consumer’s real income will fall and so its demand for the
good will also fall and due to fall in price of goid,
consumer’s real income will rise so demand for good rise.
Thus, negative income effect o change in price of normal
goods reinforces their SE and both these effect operate in
same direction. That explains why dd curve of normal
goods os negative i.e, it slopes downwards.
Derivation of Demand Curve
with the help of Indifference
Curves
(LECTURE-15)

By: Kanika Bajaj

Derivation of demand curve
Demand curve is that curve which, other things being
equal, indicates different quantities of a good bought
by the consumer at different prices. Demand curve of
a good can be drawn with the help of Indifference
Curve. Such a demand curve is drawn on the basis of
Price Consumption Curve.
This curve indicates that income of the consumer
being given, how the demand of a good will be
effected with change in its price. It means that both
PCC and dd curve indicates different quantities of a
good demanded by the consumer at different prices.
Graph Income of the consumer is OM.
Suppose at given price of
apples , initial price line is MQ
and indifference curve is IC1.
The consumer is in eqm at pt. P.
It means consumer willing to buy
OA amount of apples.
Price of apples calculated with
help of scope (OM/OQ) of price
line MQ. Suppose this price be
Rs. 3 then dd for apples be 1
unit.
Fall in price of apples cause shift
in price line. Thus slope be
(OM/OQ1). Price be Rs.2 and dd
for apples be 2 units. Further fall
indicates another price line and
price of apples.
Uses or Significance of
Indifference Curve
Analysis
(LECTURE-16)

By: Kanika Bajaj

Usee of IC
(1) In the field of Consumption: In the sphere of
consumption, one can find out demand curve and
position of consumer’s equilibrium with the help of IC’s. A
consumer is in eqm when he consumes that combination
of two goods where price line is tangent to an IC and IC
is convex to the point of origin.
(2) Consumer’s Surplus: Prof. Hicks has used IC analysis in
order to measure Consumer’s Surplus in more realistic
manner. One can find out with the help of IC without
measuring utility in cardinal numbers, how much price a
consumer is willing to pay for a commodity rather than
go without it, or how much he actually pay. It is the
difference between two prices which is called
consumer’s surplus.
Uses of IC
(3) Complete explanation of demand: Indifference Curves are
used to study Price effect, Income effect and Substitution
Effect. IC analysis shows why dd curve of Giffen’s goods slopes
upward from left to right. Exception to law of dd is therefore
explained through IC analysis. It is complete explanation of
theory of dd.
(4) In the field of Production: Position of producer’s equilibrium
can be known with the help of IC analysis. In the field of
production, IC is known as Iso-Product curves. An iso-product
curve, represents different combinations of two factors of
production, say, land and capital, which yield the same
amount of output. A producer is in equilibrium position at that
point where an Iso-cost curve is tangent to Iso-product curve.
Uses of IC
(5) In the field of Exchange: Prof. Edgeworth has used
IC analysis to know the rate of exchange of two
goods between two individuals. If two consumers
have two goods and they want to exchange them
mutually, they will get maximum satisfaction when the
same are exchanged upto a point where MRS of
these goods equal to both the consumers.
MRS(xy) for person A = MRS(xy) for person B.
By doing so both the consumers will get maximum
satisfaction.
Uses of IC
(6) In the field of distribution: IC are used in the field of
distribution to meet many objectives. One of the
objectives is to analyse supply curve of the labour. IC
analysis explains why supply curve of labour turns
backward after a point. It is so because after reaching
a particular rate of wages, positive income effect
exceeds negative substitution effect. As such, with the
rise in wages, the labourers prefer leisure to work.
Consequently, wage-increase fails to increase the
supply of labour.
Uses of IC
(7) Effect of Rationing: With the help of IC, effect of rationing on
the satisfaction of the consumers can be ascertained. Under
rationing system, everybody gets the same quantity of rationed
article irrespective of the fact whether one receives more or less
satisfaction therefrom. For example, due to rationing of wheat
and rice in Chandigarh, every resident of that city-beautiful will
get equal quantity of wheat and rice. But a madrasi gentleman
living in chandigarh will get more satisfaction from rice than
from wheat. On the other hand, Punjabis living in chandigarh
will get more satisfaction from wheat than from rice. With the
help of IC, punjabis and madrasis would be able to decide the
rate at which they should exchange wheat and rice among
themselves so as to get maximum satisfaction.
Uses of IC
(8) Effect of change in Price Index: Effect of change
in price index on the standard of living of different
persons can also be found out with the help of IC
analysis. If, as a result of change in price index,
without there being any change in the income of the
people, they reach higher Indifference curve than
before, it would mean that change in prices has
raised their standard of living. On the contrary, if they
reach lower IC, it would mean that change in prices
has adversely affected their standard of living.
Uses of Ic
(9) Effect of Government Policy on Economic Welfare:
Effect of various government policies regarding payment
of subsidies etc. On the economic well-being of the
people can be measured with the help of IC. If, as a
result of some economic policies of the government,
people move from lower IC to higher IC, it means that
the policy has proved beneficial to the economic well-
being. On the contrary, if as a result of some economic
policies, people move from higher to lower IC, it means
that the said policy has proved detrimental to general
welfare.
Similarities and Differences
between Indifference Curve
Analysis and Utility Analysis
(LECTURE-17)

By: Kanika Bajaj

Similarities
(1) Subjective: In order
to study the behaviour of
the consumer, it is necessary to have the
knowledge of utility from the consumption of a
good. Indifference Curve is also called Iso-utility
curve, due to this reason. Utility analysis is based
on the assumption that TU derived from a good
is a summation of the utilities of different units.
Similarities
(2) Consumer is Rational: Another similarity of two
analysis is the assumption that the consumer is
rational, i.e, he seeks maximum satisfaction.
(3) Conditions of Equilibrium: According to utility
analysis, a consumer is in equilibrium when MU of
goods and their price ratios are equal. Similarly, under
IC analysis, a consumer is in equilibrium when MRS of
two goods is equal to their price ratio.
Similarities
(4) Tendency of diminishing Marginal Utility: Both the
analysis of consumer’s behaviour depend on the
tendency of the MU to diminish. The main assumption
of utility analysis is that MU has a tendency to diminish.
Likewise, convexity to the pt. Of origin of an IC
indicates the tendency of MRS to diminish. As a
consumer gets more and more of X-commodity, he
will substitute it for Y-commodity at a Diminishing rate.
Hence, both the theories are based on the
fundamental assumption of diminishing MU.
Superiority of IC / Difference
(1) Indifference Curve Analysis is more realistic:
Pareto criticized utility analysis because it measures
utility in cardinal numbers. Utility is subjective
concept. It cannot be measured in cardinal
numbers in the same way as we measure the length
of a piece of cloth or weight of a bulky good. IC
analysis is free from this defect. In this analysis utility is
measured in ordinal numbers. It is more realistic
measure of utility. On can say that one likes a cup of
coffee more than a cup of tea but one cannot say
how much one likes it.
 Superiority of IC
(2) Free from the defect of independent commodity:
According to Edgeworth, the main defect of utility
analysis is that it assumes that a consumer buys a
single commodity at a time and its utility is not
effected by the utility of other commodities. This
assumption means that complementary goods and
substitutes cannot be studied under utility analysis.
But in real life when a consumer consumes a
commodity then its utility is very much influenced by
the utilities of other goods consumed by him. IC
analysis is free from unrealistic assumption of utility
analysis.
Superiority of IC
(3) Free from unrealistic assumption of Constant
Marginal Utility of money: Marshall’s utility analysis is
based on assumption that MU of money remains
constant. In real life MU of money never remains
constant. IC analysis is free from this unrealistic
assumption.
(4) Based on less assumptions: IC Analysis have less
assumptions than utility analysis. IC is free from many
unrealistic assumptions, like, utility can be added or
subtracted, utility depend on consumption of that
very commodity.
Superiority of IC
(5) Explanation of Income and Substitution Effect:
Because of the assumption of utility analysis that MU of
money remains constant, price cannot be divided into
income effect and Substitution effect. On the contrary,
under IC analysis,price effect can be divided into IE and
SE.
(6) Explanation of Giffen’s Paradox: Utility Analysis fails to
explain Giffen’s Paradox. According to IC analysis, due
to change in price of Giffen’s goods, +ve income effect
becomes more powerful than negative Substitution
Effect. Hence, rise in price leads to increase in dd. IC
analysis is more realistic than Marshall’s Theory of
Demand.
Superiority of IC
(7) Helpful in Estimation of Welfare: One can know with
the help of IC analysis the effect of change in price on
the welfare of the consumer. If, as a result of change in
price, the consumer moves to higher IC it means increase
in welfare. Change in price can be converted into
change in real income with the help of IC analysis.
(8) More realistic foundation: The basis of utility analysis is
law of diminishing Marginal Utility. This law is based on
many unrealistic assumptions,such as cardinal
measurement of utility etc. The basis of IC analysis is law
of diminishing MRS which is based on realistic
assumptions.
Superiority of IC

(9) More realistic theory of Consumer’s Equilibrium:

Although IC analysis and utility analysis both
prescribe almost identical conditions of
consumer’s equilibrium yet IC analysis helps a
consumer reach consumer equilibrium without
any unrealistic assumptions.
Criticism of
Indifference Curve
Analysis
(LECTURE-18)

By: Kanika Bajaj

Criticism
(1) Unrealistic assumptions: Indifference Curve
Analysis is based on the assumption that a
consumer has complete knowledge regarding
scale of preference of two goods. In reality, a
consumer is not a computer. He cannot take
quick decisions in real life.
(2) Complex analysis: IC analysis can explain easily
that behaviour of the consumer which is
restricted to the combination of only two goods.
If a consumer wants combinations of more than
two goods, then IC cannot explain easily his
behaviour.
Criticism
(3) Imaginary: According to Schumpeter, IC analysis
is not based on the experience of real life. IC analysis
based on imaginary combinations. A consumer does
not decide always like a computer as to which of the
combinations of two goods he would prefer.
(4) Ignores combinations involving risk: Many a time
a consumer choose such combinations as involve risk
and uncertainty. IC analysis does not study such like
combinations. Its scope, therefore, is also limited like
that of utility analysis.
(5) Introspective: According to Samuelson, IC analysis is also
concerned with the mental activities of the man. In order to
ascertain consumer’s equilibrium through IC Analysis, it
becomes essential to know his mental functioning regarding
choice of combinations. Accordingly, Samuelson has tried to
study consumer’s equilibrium on the basis of his behaviour
through Theory of Revealed Preference.
(6) Assumption of Convexity: According to Koutsoyiannis,
another limitation of its assumption of Convexity. This theory
does not explain why an IC is convex to the pt. Of origin. In real
life, it is not necessary that all goods should have diminishing
MRS.
(7) Old wines in new bottles: Prof. Robertson does
not find anything new in the IC analysis and
considers simply ‘old wine in new bottles.’ Old terms
have been replaced by new ones. For e.g, instead
of cardinal no.’s such as 1,2,3.. Ordinal no’s I, II,
III...have been used. It makes use of scale of
preferences in place of utility and law of diminishing
MRS in place of law of diminishing MU. Likewise, both
the analyses reach the same conclusions so far as
consumer’s equilibrium is concerned.
(8) Impossible to explain Diminishing MRS without
diminishing MU: According to Prof. Armstrong
diminishing MRS cannot be explained without the help
of diminishing MU. When by giving up good-Y, one
obtains an additional unit of good-X, the MRS of good-X,
for good-Y goes on diminishing. It is so because the
good whose quantity falls its utility increases, on the
other hand, the good whose stock increases its utility
diminishes. It is evident, therefore, that without the
concept of MU one cannot explain MRS .
(9) Laughable Combinations: When we consider
different combinations of two goods, then sometimes
we come across such funny combinations that have
no meaning for the consumer. For instance, there is a
combination of 10 shirts + 2 pairs of shoes. If the
subsequent combinations shirts are given up to get
more pairs of shoes, then we arrive at a combination
representing 2 shirts + 10 pairs of shoes. This is a
ridiculous combination.
(10) Unrealistic assumption of Maximum Utility: As in case of utility
analysis, IC analysis is also based on unrealistic assumption of maximum
satisfaction. In real life, consumer is not so rational. Laws relating to
Consumer’s expenditure are very much influenced by habits, customs,
fashion etc. Under their influence many a time, consumer has to buy
such goods as may yield him little satisfaction.
(11) Impractical: According to Morris, IC analysis is based on unrealistic
assumption that goods are homogeneous. This assumption holds good
only under perfect competition, but perfect competition is an
impractical concept. In real life, we find monopolistic competition and
oligopoly of market. In these markets, there is lot of product
differentiation which has widened the scope of consumer’s choice. IC
cannot explain it satisfactory.
(12) Criticism on the basis of Indifference: IC analysis is
based on the assumption that consumer knows which of
the combinations of two goods yield him equal
satisfaction. It is only that he shows indifference towards
them. But Armstrong has criticised this assumption.
According to him, a consumer cannot make fine
distinction between two combinations in real life. So he
treats them as yielding same utility. But as the difference
of combinations goes on increasing, difference of utility
becomes evident and as such a consumer does not get
same utility from different points on same IC.
Suppose points M, N, P, Q are located on
IC. Each of these points represents
different combinations of good-X and
good-Y. These combinations are different
from the remaining three combinations. It
can be concluded that consumer may be
indifferent b/w Combinations represented
by two close pt’s. But according to
Armstrong, the consumer is indifferent b/w
M and N not because total utility of M
combination is equal to the TU of N
combination,but because of the
difference in the TU of M and N are so
minute that consumer cannot express it.
But if we compare M with Q combination,
then there will be so much difference in TU
that consumer will be able to express it.
According to Armstrong, different pt’s on a
IC do not represent equal utility
Thank you!! 😊😊
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