As income increases, an individual will typically shift their consumption level because they can afford more commodities. The result is that they will end up on an indifference curve that is farther properties of indifference curve from the origin—hence better off. The slope of the budget line is the relative price of good A in terms of good B, equal to the price of good A as a ratio of the market price of good B.

If he increases his consumption of X so as to reach the dotted portion of the I3 curve (horizontally from point S), he gets negative utility. This can be explained by considering a hypothetical situation where two indifference curves intersect. One of the basic assumptions of indifference curves is that the consumer purchases combinations of different commodities.

  1. The reason for the negative slope is that as a consumer increases the consumption of commodity X, he/ she sacrifices some units of commodity Y in order to maintain the same level of satisfaction.
  2. In this case, we have two bundles on the same indifference curve, [latex]A[/latex] and [latex]B[/latex], but [latex]B[/latex] has more of both burritos and sandwiches than does [latex]A[/latex].
  3. The major criticism of this theory is that it is based on unrealistic assumptions which question its economic viability.
  4. To keep things simple, we will focus only on goods, but it is easy to incorporate bads into the same framework by considering their absence—the fewer the bads, the better.
  5. Here, the consumer is assumed to spend on both the products by checking out all the possible combinations deriving the same utility to him.

Indifference curve being downward sloping means that when the amount of one good in the combination is increased, the amount of the other good is reduced. This must be so if the level of satisfaction is to remain the same on an indifference curve. Figure 7.14 showed Janet Bain’s utility-maximizing solution for skiing and horseback riding.

What is Long Run Cost? Type: Total, Average, Marginal

In a single commodity situation, there will be no opportunity to choose between alternatives or the concept of indifference. At point (a) on the indifference curve, the consumer is satisfied with OE units of rice and OD units of beans. He is equally satisfied with OF units of rice and OK units of beans shown by point b on the indifference curve. Two demand curves can intersect each other, while two indifference curves cannot intersect each other.

The total satisfaction of the consumer is therefore bound to be greater at Q than at P. This implies that as the consumer continues to substitute commodity X for commodity Y, MRS of X for Y diminishes along the IC. When the indifference schedule for X and Y is plotted on a graph, a curve is obtained, which is shown in Figure 1.

Chapter 8: Theory of Supply

An indifference curve is a graph of all the combinations of bundles that a consumer prefers equally. In other words, the consumer would be just as happy consuming any of them. Representing preferences graphically is a great way to understand both preferences and how the consumer choice model works—so it is worth mastering them early in your study of microeconomics. The slope of the curve shows the rate of substitution between two goods, i.e. the rate at which an individual is willing to give up some quantity of good A to get more of good B. If we assume that the individual likes both goods, the quantity of good B has to increase as the quantity of good A decreases, to keep the overall level of satisfaction the same. Because both axes each represent one of the two goods, this relationship results in a downward sloping curve.

Consistency and Transitivity of Choice

To prove that no two indifference curves can intersect, we can use the concept of transitive preferences. If two indifference curves intersected, then there would be a combination of goods that provides the same level of utility as two different combinations of goods. However, this would contradict the assumption of transitive preferences, as the consumer would be indifferent between two different combinations of goods at the same time.

The greater the fall in marginal rate of substitution, the greater the convexity of the indifference curve. The less the ease with which two goods can be substituted for each other, the greater will be the fall in the marginal rate of substitution. It is only on the negatively sloped curve that different points representing different combinations of goods X and Y give the same level of satisfaction to make the consumer indifferent. We measure the quantity of rice along the X-axis and beans along the Y-axis.

This property implies that an indifference curve has a negative slope. At point C, the consumer purchases only OC of beans and no rice. Similarly, at point E, he buys the OE quantity of rice and no beans. If indifference curves are allowed to intersect, it will break down the assumptions of transitivity and consistency. Similarly, the combinations showed by points B and E on indifference curve IC1 give equal satisfaction to the consumer.

If the consumer increases his consumption beyond X and Y his total utility will fall. If the marginal rate of substitution had increased, the Indifference Curve would have been concave to the origin. If the marginal rate of substitu­tion had remained constant, the Indifference Curve would have been a diagonal straight line at 45° angle.

The marginal do not rate of substitution increases nor does it remain constant. The marginal rate of substitu­tion on the contrary goes on diminishing. So the Indifference Curve has to be convex to the origin of axes. The consumer ranks his preference according to the satisfaction of each combination. He does not know actually his satisfaction but he always expresses his preferences for the various bundles of commodities. Hence ordinal utility measurement is necessary and not cardinal measurement.

For a consumer who buys only two goods, the budget constraint can be shown with a budget line. A budget line shows graphically the combinations of two goods a consumer can buy with a given budget. As we have already seen, a consumer’s choices are limited by the budget available. Total spending for goods and services can fall short of the budget constraint but may not exceed it. Other critics note that it is theoretically possible to have concave indifference curves or even circular curves that are either convex or concave to the origin at various points. For example, the x-axis may measure the quantity of food available while the y-axis measures the risk involved in obtaining it.

Two commodities model

She is also on her budget line; she is spending all of the budget, $250, available for the purchase of the two goods. How does the achievement of The Utility Maximizing Solution in Figure 7.13 correspond to the marginal decision rule? That rule says that additional units of an activity should be pursued, if the marginal benefit of the activity exceeds the marginal cost. The observation of that rule would lead a consumer to the highest indifference curve possible for a given budget. We can draw an indifference curve through any combination of two goods. Figure 7.11 shows indifference curves drawn through each of the points we have discussed.