Presentation on theme: "The Indifference Curve Analysis is an alternative explanation of the consumer’s behaviour. It is an alternative in two respects : Different assumptions."— Presentation transcript:
The Indifference Curve Analysis is an alternative explanation of the consumer’s behaviour. It is an alternative in two respects : Different assumptions and different tools. Let us see how assumptions and tools are different.
The Utility analysis is assumed as cardinal i.e. the utility is expressed in exact units as 1,2,3 etc. The Indifference Curve analysis is assumed as Ordinal as the Utility is expressed as first, second, third, etc. The assumption of Ordinal Utility is more realistic than the assumption of cardinal utility. In this respect, the Indifference curve analysis is considered to be an Improvement over the Utility Analysis.
The Utility analysis uses (i) The concept of Marginal Utility. (ii) The law of diminishing marginal Utility. (iii) The law of Equi-marginal Utility. The Indifference curve analysis uses (i) The concept of Indifference Curve. (ii) Budget line.
An Indifference Schedule is a table showing different combinations of the goods such that utility from each combination is the same. Assumptions (i) As the quantity of one good is increased, quantity of the other good must be decreased. (ii) As the Quantity of one good goes on increasing, the quantity of the other good not only decreases, but decreases at a decreasing rate.
Combination Soft Drinks Chocolate Chocolate A 4 14 14 B 5 10 10 C 6 08 08 D 8 06 06 E 12 12 05 05
MRS is a rate at which the consumer is willing to sacrifice on good to Obtain one more unit of the other good. Combination Combination MRS MRS A - B 1X : 4Y 1X : 4Y C 1X : 2Y 1X : 2Y D 2X : 2Y 2X : 2Y E 4X : 1Y 4X : 1Y With reference to the Table 1. MRS = Change in the q.ty of good sacrificed. Change in the q.ty of good obtained. For Example, for the combination B MRS = Y X => -4/1 = 4 (absolute value)
The Indifference curve is the locus of different combinations of the two goods, the consumer consumes with each of the Combination having the same utility. Soft Drinks Soft drinks Marginal rate of substitution of soft drinks for chocolate. Y X
Soft Drinks The set of all possible Indifference curves, the consumer has, is called Indifference map. The Indifference map is based on the assumption that the preferences are monotonic. Monotonic preferences mean that as consumption increases, total utility also increases along with it.
(i)Sloping downwards from left to right. Because, to obtain more quantity of one good, the consumer must give up some quantity of the other good in order to remain at the same utility level. (ii) Strictly convex towards the origin. Because, the MRS continuously declines as the consumer moves downwards along the curve. (iii) Higher Indifference curve represents higher utility. Because, assumptions are based on monotonic preferences.
Budget set refers to the set of possible combinations of the two goods, the consumer consumes which he can afford from his income and given prices. This situation can be expressed in the form of an equation in the following way : P x. X + Py. Y < m The Equation is often referred to as Budget Constraint.
A budget line is the Graphical presentation of the whole collection of the combinations of two goods, which costs the consumer exactly his income. Budget line is the locus of different combinations of two goods, which the consumer consumes and which cost the consumer exactly his income. The rate at which at which, the market requires sacrifices of one good to obtain extra unit of the other good is called Market Rate of Exchange (MRE).
Combinations Good X Good Y M.R.E M.R.E A 0 20 0 205Y:1X B 1 15 1 155Y:1X C 2 10 2 105Y:1X D 3 05 3 055Y:1X E 4 00 4 005Y:1X Consumption Possibility Schedule
3 Budget set Graphical presentation MRE = Quantity of the good needed to be sacrificed Quantity of the good needed to be obtained Slope = Qty of the good sacrificed Qty of the good obtained Or Price of the good Obtained Price of the good Sacrificed = Y X = Px/Py
Budget line shifts because of the following changes. (a)Change in the Income. (i) If income Increases(ii) If Income Decreases A 1 A BB 1 A B A 2 B 2
(b) Change in price of good X. A B (i) If price of Good X falls. B 1 (ii) If price of Good X rises. A B B 2
(c) Change in the price of Good Y. (i) If the price of Good Y falls. A B A 1 A B (ii) If the price of Good Y rises A 2
Consumer Equilibrium means the combination of Two goods, which the consumer can afford and which gives maximum satisfaction he possibly can get. A Consumer will be in equilibrium when the Indifference curve is tangent to the Budget line. The Consumer equilibrium will be at a point where the budget line meets the Indifference curve.
(a) The Consumer is rational. (b) The Utility is expressed ordinally. (c) MRS decreases as more of one good is consumed by willingly sacrificing the other good. (d) Utility is increasing function of Consumption. he Marginal Rate of Substitution (MRS) equals the Market Rate of Exchange (MRE). (b) MRS falls as more of one good is consumed in place of the other.
Graphical Presentation. A B Y X Good X Good Y x 1 y 1 F G
(1) What does the MRS equal ? (2) What does the slope of the budget line equal ? (3) How does the budget line change if the consumer’s income and Prices of both the goods change in the same percentage and same direction ? (4) What conclusion can you draw from the presentation?