Introduction to Economics

Eco-101
Consumer behavior
Ordinal Approach/ Indifference Curve Analysis
Instructor: Miss Moniba Sana
 Indifference Curves

• Indifference curve: a curve showing all the

combinations or bundle of two goods which yield
the same level satisfaction to the consumer so that
he is indifferent among these combination.
• We can say that these bundles of consumption
make the consumer equally happy.
 Shape of Indifference Curve
• The indifference curves are not likely to be
vertical, horizontal, or upward sloping.
• A common shape for an indifference curve is
downward sloping.
– For the consumer to be indifferent to the bundle of
goods chosen, as less of one good is consumed,
more of another must be consumed to remain
equally happy.
 Shape of
Indifference
Curve

Copyright © Houghton Mifflin Company. All rights 4

reserved.
 Slope of Indifference Curve
• The slope or steepness of indifference curves is
determined by consumer preferences.
– It reflects the amount of one good that a consumer must
give up to get an additional unit of the other good while
remaining equally satisfied. It is known as Marginal
Rate of Substitution (MRS)
– This relationship changes according to diminishing
marginal utility—the more a consumer has of a good,
the less the consumer values an additional value of that
good. This is shown by an indifference curve that bows
in toward the origin. This notion is known as
Diminishing Marginal Rate of Substitution DMRS

Copyright © Houghton Mifflin Company. All rights 5

reserved.
 Indifference Map
• An indifference map is a complete set of indifference
curves.
• It indicates the consumer’s preferences among all
combinations of goods and services.
• The farther from the origin the indifference curve is,
the more the combinations of goods along that curve
are preferred. It means higher indifference curves will
be preferred to lower ones

Copyright © Houghton Mifflin Company. All rights 6

reserved.
Indifference
Map

Copyright © Houghton Mifflin Company. All rights 7

reserved.
Assumptions of Indifference Curve Theory

• Rationality: it is assumed that consumer is rational _means has full

knowledge about market conditions and aware of his costs and benefits.
• Utility is Ordinal: this theory assumes that consumer can rank all his
preferences according to the level of satisfaction without precisely
quantifying the utility.
• Consistency: It is assumed that consumer is consistent in his choice,
if in one period he prefers bundle A over B he will never choose B over
A in another period if both bundles are available to him
• Transitivity: consumer choices should be transitive. If bundle A is
preferred to B , and b is preferred to , Then bundle A must be preferred
to C. Symbolically it means
If A > B ,and B >C , then A >C
 Properties of Indifference Curve
• Higher indifference curves are preferred to lower
ones. As higher indifference curve represent larger
quantities of goods than the lower ones
• Indifference curves are downward sloping. If a
consumer wants to increase the quantity of one thing
he has to reduce the units of other products
• Indifference curves are bowed inward. The
diminishing marginal rate of substitution causes the
indifference curve to bow inward or convex to the
origin
 Indifference curves do not cross

• Indifference curves cannot cross.

• If the curves crossed, it would
mean that the same bundle of
goods would offer two different
levels of satisfaction at the same
time. (C & B)
• If we allow that the consumer is
indifferent to all points on both
curves, then the consumer must
not prefer more to less.
• There is no way to sort this out.
The consumer could not do this
and remain a rational consumer
 Budget Constraint
• The indifference map only reveals the ordering of
consumer preferences among bundles of goods. It
tells us what the consumer is willing to buy.
• It does not tell us what the consumer is able to buy. It
does not tell us anything about the consumer’s buying
power.
• The budget line shows all the combinations of goods
that can be purchased with a given level of income.

Copyright © Houghton Mifflin Company. All rights 11

reserved.
 Shifts in The
Budget Line
the slope of budget line is indicated as the
price ratios of both commodities can be
expressed as PX/PY Copyright © Houghton Mifflin Company. All rights
reserved.
 Consumer Equilibrium
• The indifference map in combination with the budget line
allows us to determine the one combination of goods and
services that the consumer most wants and is able to
purchase. This is the consumer equilibrium.
• It means consumer will be in equilibrium when higest
indifference curve will touch the lowest budget line or the
slopes of both curves is same. Symbolically this point of
tangency of both curves can be expressed as
MRS or Dy/Dx= Px/Py

Copyright © Houghton Mifflin Company. All rights 13

reserved.
 Consumer
Equilibrium

The consumer maxi-

mizes satisfaction by
purchasing the
combination of
goods that is on the
indifference curve
farthest from the
origin but attainable
given the
consumer’s budget.

Copyright © Houghton Mifflin Company. All rights 14

reserved.
Deriving the Individual
Demand Curve

By changing the price of

one of the goods and
leaving everything else
the same, we can derive
the demand curve.

In (a), the price of a gallon

of gasoline doubles,
rotating the budget line
from Y1 to Y2. The
consumer equilibrium
moves from point C to E,
and the quantity
demanded of gasoline
falls from 3 to 2.
Copyright © Houghton Mifflin Company. All rights 15
reserved.