Introductory Economics

Introduction

Indifference Curve:

• This approach is based on ordinal utility.
• The household can choose among combinations without assigning numerical values to utility. In other words, the term ordinal means, ranked or ordered, first, second and third are ordinal numbers. Hence this implies that indifference curve analysis is based on ordinal measurements.
• Indifference curve is a curve which shows different combinations of two goods which yield equal level of satisfaction to the consumer.
• It means that different combinations of two goods, yielding same level of satisfaction to the consumer makes him indifferent about his choice among the different combinations. In other words, he gives equal importance to all the combinations on a given indifference curve. Hence an indifference curve represents a set of possible consumption bundles between which the individual is indifferent.
• Indifference Schedule: An indifference schedule may be defined as the schedule of various combinations of goods that will yield equal level of satisfaction to a consumer.

For example:

Combination of ( Say ) Apple and Bananas	Apple	Bananas
A	1	10
B	2	7
C	3	5
D	4	4

The schedule shows that the consumer gets equal satisfaction from all the four combinations of apple and bananas.

Indifference curve: The diagrammatic presentation of indifference schedule is indifference curve.

Different points A, B, C and, D on the indifference curve indicate the different combinations of apple and bananas which yield equal satisfaction to the consumer. This curve is also known as Iso- Utility curve.

Indifference map: indifference map is the collection of indifference curves possessed by an individual i.e. a complete description of consumer’s taste and preferences. For example IC map is presented in the figure below.

Marginal rate of substitution:

• An indifference curve shows that a consumer derives equal level of satisfaction by consuming the different combination of goods. If a consumer gets one more unit of good X, he has to give up some units of the other good Y in order to derive the same level of satisfaction.
• In other words, the exchange for the satisfaction obtained from the additional unit of good X he will have to give up some units of the other good Y whose satisfaction is equal to the additional unit of good X.
  
• Hence, Utility gained of Good X = Utility lost of other good Y
  

“Marginal rate of substitution is the rate at which the consumer can substitute one good for another good without changing the level of satisfaction. It indicates the slope of the indifference curve.”

Given below is the indifference schedule of a consumer who derives equal level of satisfaction by consuming the different combinations A, B, C., D and E. When the consumer moves from combination B to C on his indifference schedule he foregoes 3 units of Y for the additional one unit of X. Hence marginal rate of substitution of X for Y is 3. and likewise for other combinations.

Indifference Schedule

Combinations of Good X and Y	Good X	∆X	Good Y	∆Y	MRSXY
A	1		12
B	2	1	8	4	4
C	3	1	5	3	3
D	4	1	3	2	2
E	5	1	2	1	1

MRS_XY = _ΔY /_ΔX

Law of Diminishing Marginal Rate of Substitution:

• The law of diminishing marginal rate of substitution states that as a consumer gets more and more units of good X, he will be willing to give up less and less of good Y to remain at the same level of satisfaction.

For example marginal rate of substitution of good X for Good Y is shown in the table below.

Combinations	Good X	Good Y	MRSXY
A	1	10
B	2	7	1:3
C	3	5	!:2
D	4	4	1:1

• As is evident from this table that consumer will give up 3units of good Y to get second ,then 2units of good Y to get third unit of good X and so on. This law can also be illustrated through figure shown below.

 

Now it comes to one’s mind what accounts for the diminishing marginal rate of substitution. The following three factors are responsible for diminishing marginal rate of substitution.

• The want for a particular good is satiable so that as the consumer has more of a good the intensity of his want for that good goes on declining.. it is because of this fall in the intensity of want for good say X, that when its stock increases with the consumer, he is prepared to forego less and less of good Y for every increment in X.
• The second reason for the decline in marginal rate of substitution is that the goods are imperfect substitutes of each other. If two goods are perfect substitutes of each other then they are to be regarded as one and the same good, and therefore, increase in the quantity of one and decrease in the quantity of the other would not make any difference in the marginal significance of the goods.
• Thirdly the law of diminishing marginal rate of substitution will hold good only if the increase in the quantity of one good does not increase the want satisfying power of the other good.