Indifference Curve Analysis: Concept, Assumption and Properties
Only when the negative income effect is powerful enough to outweigh the substitution effect can the demand curve slope upward to the right instead of sloping downward to the left. We, therefore, conclude that indifference curves cannot cut each other. We will make use of this relation extensively when we come to the study of price determination under different market conditions. With the above information we draw up the demand schedule in Table 8. Case Study Ms Amita's Indifference Curve is based on her commodity baskets of rice and wheat.
Therefore it is impossible for both curves to provide the same level of satisfaction, which means they can never intersect. The marginal rate of substitution is either zero or infinite. The new choice is B, the point of tangency between the new budget constraint and the lower indifference curve. The actual values of the function have no importance. One final note: The helpful dashed line can be drawn tangent to the new indifference curve, and parallel to the original budget line, rather than tangent to the original indifference curve and parallel to the new budget line. These curves are downward sloping consistent with assumption 3 if they were upward sloping, horizontal, or strictly vertical they would violate the condition of more is preferred to less.
The highest achievable indifference curve touches the opportunity set at a single point of tangency. There are three basic reasons for the downward sloping aggregate demand curve. In this case, the substitution effect would lead Petunia to choose less leisure, which is relatively more expensive, and more income, which is relatively cheaper to earn. An introduction to positive economics fourth ed. Does a change in income have both an income effect and a substitution effect? When the price of a commodity is relatively high, only a few consumers can afford to buy it. Several possibilities are identified in the diagram.
There is an additional reason why the market demand curve for a commodity slopes downward. Indifference curves for other people would probably travel through different points. Similarly, rate of decrease in consumption of coffee has gradually decreased even with constant increase in consumption of cigarette. This induces the consumer to the commodity whose price has fallen for other commodities which have now become relatively dearer. In other words, they are steeper on the left and flatter on the right.
What are the Properties of Indifference Curve? Business Jargons
A normal indifference curve will be convex to the origin and it cannot be concave. The substitution effect is that when a good becomes more expensive, people seek out substitutes. If total utility is to remain constant, an increase in the consumption of one good must be offset by a decrease in the consumption of the other good, so each indifference curve slopes downward to the right Because of the law of diminishing marginal rate of substitution, indifference curves bow in toward the origin. If you are finding it a little tricky to sketch diagrams that show substitution and income effects so that the points of tangency all come out correctly, it may be useful to follow this procedure. But at this stage, draw only the new budget set. Indifference curves are widely used in microeconomics to analyze consumer preferences, the effects of subsidies and taxes, and a few other concepts. Quentin also has an income effect motivation.
What are the Properties of Indifference Curve? Business Jargons
The income effect is the shift from C to B; that is, the reduction in buying power that causes a shift from the higher indifference curve to the lower indifference curve, with relative prices remaining unchanged. In different models these indifference curves can be used to identify preferences for combinations of: different products, consumption spending in the present and in the future, work-time and leisure time, or financial risk and return. However, the income effect of a higher price for pizza meant that he wished to consume less of both goods, and this factor, taken alone, would have encouraged Ogden to consume fewer haircuts. The income effect motivation encourages a utility-maximizer to buy more of both goods if utility rises or less of both goods if utility falls if they are both normal goods. This substitution effect is more important than the income effect. Utility-Maximizing with Indifference Curves People seek the highest level of utility, which means that they wish to be on the highest possible indifference curve. An indifference curve shows combinations of goods between which a person is indifferent.
They eliminate any need for placing numerical values on utility and help to illuminate the process of making utility-maximizing decisions. It implies that the consumer still has the willingness to consume more of both the goods. To understand why higher indifference curves are preferred to lower ones, compare point B on indifference curve Um to point F on indifference curve Uh. With a further fall in price to Rs. One can also refer to each point on the indifference curve as rendering the same level of satisfaction for the consumer. This means, any combination of two goods on the higher curve give higher level of satisfaction to the consumer than the combination of goods on the lower curve.
4 Important Properties of Indifference Curve (with curve diagram)
Thus, indifference curve is always convex neither concave nor straight. Conversely, if the price of a good that you have been buying rises, then the buying power of a given amount of income is diminished. This substitution effect is more important than the income effect. Again, the language of substitution and income effects provides a framework for thinking about the motivations behind various choices. Indifference curves cannot intersect each other The indifference curves never cut each other as higher and lower curves show different levels of satisfaction. For a single consumer, this is a relatively simple process.
A negative slope and transitivity exclude indifference curves crossing, since straight lines from the origin on both sides of where they crossed would give opposite and intransitive preference rankings. Pen and ink, right shoe and left shoe, automobile and petrol sauce and hamburger, type writer and typists are some examples of perfect complements. Thus, the consumer will definitely prefer A to B, that is, A will give more satisfaction to the consumer than B. What Is an Indifference Curve? As price rises for a fixed money income, the consumer seeks the less expensive substitute at a lower indifference curve. Thus, this theory is also known as ordinal approach.
