Indifference Curve

Developed first by Francis Ysidro Edgeworth in his seminal 1881 book, the theory of Indifference Curves is a vital component of ordinal utility and consumer theory. Used worldwide to predict and judge consumer behavior, the approach prefers the study of consumer preferences, instead of measuring them in terms of money.

So, What is an Indifference Curve? Well, it is a graphical representation that goes on exploring the way a consumer might be found to be indifferent towards two goods or products. These goods or products are the ones that give them the customer satisfaction and utility to the same level. And in such a graph, it can be determined how a consumer’s preferences and budget constraints might change or affect their decisions. Other than these, you can find there to be other applications of the Indifference Curves as well, which include welfare economics along with the marginal utility theory.

Indifference Curve Analysis

It is the functionality of an Indifference Curve that can be explained under many assumptions. It is known that each and every Indifference Curve has an origin. Another fact is that there are no intersections between any sorts of pairs of Indifference Curves.

One of the assumptions, after much research, determines that consumers are much more inclined towards satisfaction or are satisfied when they buy goods which are on a high Indifference Curve.

The Following Example helps illustrate this:

Samaira has 1 unit of food and 12 units of books. When asked how many units of books she is willing to give up in exchange for an additional unit of food, she responds saying she could give up 6 units of books for an additional unit of food. Thus we have two situations at hand:

Samaira gains satisfaction from having 1 unit of food and 12 units of books.

She is also satisfied with 2 units of food and 6 units of books.

As Samaira is faced with more such questions, an interesting scenario is observed.

The analysis of an Indifference Curve can be carried out on a simple two-dimensional graph. Each axis indicates a specific type of product. If the graph lies on a curve or line, it suggests that the consumer has almost no preference for any product, because all of the products deliver the same kind of satisfaction or utility to the consumer. 

Samaira’s indifference can be analyzed with the following graphical representation of her Indifference Curve.

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Any combination lying on Samaira’s Indifference Curve yields the same kind of satisfaction to her. It is also called an Iso-Utility Curve.

Other Indifference Curve examples would include a teenager who might be indifferent between owning two band tee-shirts and one novel, or four novels and one band tee-shirt.

What is an Indifference Map?

A set of multiple Indifference Curves is known as an Indifference Map. This map demonstrates a summary of the consumer’s preferences for a product or set of products. Here’s a diagram to help you understand an indifference map better:  

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The figure above, consisting of three Indifference Curves, speculates the view that a consumer is indifferent to the combinations of products on the same Indifference Curve. Also, a consumer, say Samaira, would prefer the combinations on the higher Indifference Curve to the ones on the lower curves. A higher Indifference Curve indicates higher levels of satisfaction – combinations on IC2 yield greater satisfaction than those on IC1. 

Now that you know what an Indifference Curve is and how to analyze one, it’s time to revise a few concepts.

Test Your Knowledge

1. The further an IC is from its origin, the ________ :

1. higher is the satisfaction level

2. lower the satisfaction level

3. same satisfaction levels are obtained

4. None of these

2. Does an Indifference Curve exhibit various possible combinations of two products that yield equal satisfaction to the consumer?

1. Yes

2. No

What is the Marginal Rate of Substitution?

The MRS or Marginal Rate of Substitution can be defined as the rate at which a consumer is prepared to exchange a product, M for another product, N. It can also be denoted by the slope of the curve. To understand this, let’s take a close look at Samaira’s situation.

As mentioned above, Samaira initially agreed to give up 6 units of books in exchange for an additional unit of food. Hence, the MRS for Samaira is 6. From the table, you can observe that in subsequent combinations, the MRS is 2 and 1. 

Thus the MRS of a product M for N is the quantity of N that can be compensated by an additional unit of M. Both situations yield the same level of satisfaction to the consumer in question. To help make this clear, it is imperative to learn the fundamental properties of Indifference Curves that are clarified in the next section.

But before you start off with the varied characteristics of Indifference Curve, it is important to first understand the following points:

As Samaira is handed more units of food, she increasingly feels a desire for more and more units of food.

Most of the products, the books and the food, are really very flawed substitutes for one another. If these could be substituted perfectly, the MRS would remain the same.

Test Your Knowledge

1. What is the shape of the Indifference Curve, when the MRS between product M and product N diminishes?

1. Convex to the origin

2. Concave to the origin

3. A straight line

4. None of these

Features of Indifference Curve

There are several analyses that have taken place for Indifference Curves that have deduced the fact as to how the income of a consumer can change their preferences. Practically, as their income increases, the curve goes higher as well. This means that the consumer can now afford a product that they could not have earlier. 

Various studies suggest that a majority of the consumption of goods takes place at the point where the consumer’s spending capacity meets the Indifference Curve. 

Here are a few of the properties of an Indifference Curve that will make you understand it more easily:

1. It has been observed that an IC predominantly slopes downwards, to the right. This means that when the quantity of one product in combination with another is increased, the quantity of the other significantly decreases.

2. From Samaira’s example above, you learnt that as she trades in more and more clothing for food, she is willing to part with less clothing. This indicates a decreasing MRS. This diminishing rate leads to the convex shape of the Indifference Curve. Also:

1. If two products can be perfectly replaced with each other, the Indifference Curve turns out to be a straight line with a constant value of MRS.

2. If two products are perfect complements of each other, say a phone and a tablet, then in such a case, the curve is L-shaped and convex to the origin.

3. A higher curve means a higher level of satisfaction, in contrast to a lower curve.

4. It is generally known that two Indifference Curves never intersect each other. They may not always be parallel to each other as well. 

5. An Indifference Curve never touches the axis.