The utilization of the analytical approach according to modern demand theory. It is known as indifference curve approach analysis. The theory is based on the ordinal measurement, and the name indifference states. It helps the consumer is not upset to know about the combination of goods. Also, they get if they are all along the curve and are yielding the same utility. These curves are sometimes known as utility curves.
The representation of different combinations of two goods on a curve is done by an indifference curve approach. It provides equal satisfaction to consumers. Between these curves, the consumer is indifferent as he gets equal satisfaction from all the combinations.
According to Prof. Leftwich, “The different combinations of X and Y is shown by a single indifference curve that yields equal satisfaction to the consumer”.
Top 7 Assumptions of Indifference Curve Approach
1. Rationality
A consumer is an individual of sound mind who wants to maximize his satisfaction in indifference curve approach.
2. Ordinal Utility
Preferences are ranked by the consumer according to the satisfaction of each combination.
3. Non-satiety
Preference is given to goods larger than to a smaller amount by the consumer whereas other things are the same.
4. Consistency
If the consumer chooses combination A over B at a given time. At this moment, he does not choose the combination B over A at some other time despite the availability of both combinations. It is under the assumption that the consumer’s behavior is consistent over the period in indifference curve approach.
Transit of Choice: It means if A = B, B = C, then A = C
5. Diminishing Marginal Rate of Substitution
Satisfaction is constant, and the quantity of one good is given up in exchange for one unit of the other good. It is termed the marginal rate of substitution. Hence, the marginal rate of substitution of X for Y is as follows:
MRS, y =AY Decrease in Units of Y
AX Increase in Units of X. MRSxy diminishes; when the consumer consumes an additional X unit, the units of goods Y are discarded at a diminishing rate.
6. Scale of Preferences is Independent of Market Prices
Under the assumption that the consumer is not affected by his preferences. Therefore, indifferent between the combinations by the market prices of other goods.
7. Weak Ordering
The ordering form of the choice hypothesis is weak, which is the basis of the indifference curve analysis.
Properties of Indifference Curve Approach
1. Negative Slope
The slope of the indifference curve is always downward from left to right because the consumer consumes additional units of a commodity. Therefore, results in discarding some units of other goods by the consumer so that the level of satisfaction is maintained on an indifference curve approach.
According to the figure, IC is an indifference curve where a consumer moves to combination B from A. He sacrifices HA units of goods Y to consume additional units of goods X, i.e ., HB (X1X2). Supposing the slope of the IC is upward to the right it is parallel to the axis-X or axis-Y. There is a single IC that is unable to yield equal satisfaction from different combinations on the curve.
2. Indifference Curves are always Convex to the Origin
This property of an indifference curve approach is based on a diminishing marginal rate of substitution, which is the assumption of indifference curve approach. When the consumer goes from A to B, B to C, and C to D combination, each time. He takes one additional unit of goods X and gives EA, FB, and GC units of goods Y, respectively. Therefore, MRSxy is diminishing when:
He goes from A to B, B to C, and C to D combination because of EA > FB > GC. An indifference curve cannot be a straight line or concave to the origin because the marginal substitution rate will be the same or increase respectively.
3. Higher Indifference Curve represents Higher level of Satisfaction
In an indifference map, a higher indifference curve represents those combinations that give more satisfaction than the combinations on a lower indifference curve. It is an essential part of the indifference curve approach.
In both A and B combinations, the quantity of goods-X is equal (OQ), but the quantity of goods-Y in combination A is ON, greater than the quantity of Y (OM) in combination B. Therefore, the satisfaction of combination ‘A’ (a higher IC) is greater than the satisfaction of combination B.
4. Two Indifference Curves can Never cut Each Other
The reason is that different indifference curves represent different levels of satisfaction. If two IC cut each other at a point, then it means that at that point. The level of satisfaction is the same on the two indifference curves, but it is impossible.
- Taking IC1, by definition, the satisfaction of P = B (Both on IC, curve)
- Taking IC2, by definition, the satisfaction of P = B (Both are on the IC2 Curve)
- Satisfaction of A and B combinations must be equal (A = B)
But the satisfaction of A + B, because the quantity of both goods is equal in the two combinations. Also, the quantity of goods Y in combination A is greater than in combination B. Therefore, two indifference curves can never intersect each other.
5. Indifference Curve neither Touches X-axis nor Y-axis
Indifference curves have the basic assumption that the consumer purchases combinations of different commodities. Therefore, he is not supposed to purchase only one commodity because the indifference curve will touch that axis. Purchasing only one commodity means monomania. The consumer’s lack of interest in the other commodity or his insistence on purchasing only one commodity. The figure shows an indifference curve meeting the horizontal axis at C and a vertical axis at D:
It violates the basic assumption of indifference curves because, at point C, the consumer is purchasing OC of commodity A. Similarly, at point D, the consumer purchases only commodity B, and nothing of commodity A. This is against the basic assumption that the consumer always purchases the two commodities in a combination.
6. Indifference Curve Need not be Parallel to Each Other
Indifference curves need not be parallel. They can be parallel to each other only if the two commodities are shown on the horizontal axis. On the other hand, the vertical axis is independent of each other in the sense that they are neither substitute nor complementary goods. Furthermore, none of them is inferior or superior to each other whatever the amount of each with the consumer.
The assumption of independence and absence of any income effects by Dr Marshall, if introduced in the indifference curves. It gives us a set of indifference curves parallel to each other and always equidistant from one another. This is an extreme case. Normally, a consumer demands related goods for which the income effect is positive. Therefore, the normal position of indifference curves is that they converge on both sides as we go left upwards or right downwards. They do not meet.
Marginal Rate of Substitution
When total utility remains constant and the utility good of one good is given up. Then, the consumption of other goods increases by one unit.
According to Professor Bilas,” Marginal Rate of Substitution of X for Y is defined as the amount of Y the Consumer is just willing to give up getting one more unit of X and Maintaining the same level of satisfaction.
Marginal Rate of Substitution = Change in the Consumption of One Good / Change in the Consumption of Another Good
The slope of the indifference curve approach defines the Marginal Rate of Substitution (MRS). It is the rate at which one good is substituted for another good by a consumer without changing the level of satisfaction.
Top 5 Significance of Indifference Curve Approach
1. Theory of Production
Basically, a producer intends to attain a low-cost combination. Indifference curves are useful and are known as iso-product curves in the theory of production. When one of the iso-product curves on the map is tangent to the Producer’s budget line at the point at which a low-cost combination is obtained, i.e ., the Producer’s equilibrium.
2. Theory of Exchange
The exchange of two goods between two consumers results in mutual gains shown by the technique of indifference curves being used by Prof. Edgeworth. Due to exchange, it was possible for both the consumers to attain a higher level of satisfaction. Therefore ‘Contract curves’ helped explain the process of shifting to a higher level of satisfaction.
3. Field of Rationing
The indifference curve technique is also useful in the field of rationing. Usually, there is a rationing of two commodities to different individuals without their preferences. Still, if the preference of these individuals. The amounts of the two commodities are distributed following their scale of preferences among consumers. Each of the consumers will be able to search for a higher indifference curve and satisfaction.
4. Measurement of Consumer’s Surplus
The old Marshall’s concept of consumers’ surplus buried for a decade under the weight of the unrealistic and imaginary assumptions has been rehabilitated by the indifference curve technique. Thus, without making unrealistic assumptions, this technique helps in the measurement of consumer surplus.
5. Field of Taxation
The application of this technique in choice testing between a direct and indirect tax shows that a direct tax is preferable to indirect tax regarding its effects on consumption and satisfaction of the taxpayer with the help of indifference curves.
Top 7 Criticisms of Indifference Curve Approach
1. Unrealistic Assumptions
The basis of this indifference approach is in the assumptions that are unreal logic, imperfect competition, having perfect knowledge of the scale of preference to the consumer, and that the goods are divisible. Because habits, customs, and fashion affect the purchases of the consumer to a greater extent. Hence, he is not rational in his actions, and one cannot expect a consumer to know his indifference map because goods are not divisible, and perfect competition is a myth.
2. No Novelty
Prof. D.H. Robertson remarked that the indifference curve technique is mere “An old wine in a new bottle”. As this is similar to the utility analysis and has changed the existing names to new names like utility concept is replaced by the scale of preference, diminishing marginal utility has been replaced by diminishing marginal rate of substitution, and ordinal numbers replace cardinal numbers.
3. Indifference Curve is Non-Transitive
According to Prof. W.E. Armstrong’s argument, a consumer not being able to perceive the difference between close alternative combinations leads to his indifference between the two. The reason why the different combinations on the same indifference curve do not yield equal satisfaction is the increase in the difference of combinations as the difference in the satisfaction of different combinations is evident. Hence, considering the acceptance of Armstrong’s argument, different points give different satisfaction on an indifference curve resulting in the indifference curve becoming non-transitive.
4. Fails to Explain Risky Choice
The indifference curve is criticized for choosing among those alternatives involving risk or uncertainty of expectation and unable to explain consumer behavior. There emerges a need for quantitative measurement of utility to decide whether to take the risk in choosing among uncertain alternatives. Thus, consumer behavior could be explained by a coordinate system of utility in such situations.
5. Absurd and Unrealistic Combinations
Assumed combinations are the basis of indifference curve analysis. Considering these different combinations of two goods where some of them are meaningless and impossible in real life.
6. Does not Provide Behaviouristic Explanation of Consumer Behaviour
The indifference map’s character is hypothetical and subjective and does not depend upon observed market behavior because marketing functions and curves are not set in purely objective terms. The possibility of obtaining quantitative data leads to pure objective indifference curves. It is difficult to quantity indifference curves due to the logical structure of the indifference curve theory. However, success is still limited despite several attempts to quantity indifference curves.
7. Based on Weak Ordering
The hypothesis of weak ordering, which is subjective, is the basis of indifference curve analysis where a consumer can be indifferent between a large number of combinations.
Indifference Map
The indifference map is the family of indifference curves. The drawing of the indifference curves on the assumption that consumers have only one indifference curve where a particular level of satisfaction is assigned to the various combinations of two commodities. The indifference curve drawn will either be higher or lower than the one drawn already. Hence, the higher level of satisfaction is shown by higher indifference curves since the consumer prefers more goods. Whereas the lower level of satisfaction is indicated by the lower indifference curves that include less of at least one of the two commodities for the consumers
In the figure, four indifference curves are numbered to show that a higher number is assigned to the higher indifference curve in the preference scales. The curve IC2 than IC shows a higher level of satisfaction, and with IC3 and IC4, each indifference curve displays the utility of the bundle of goods. In an ordinal sense, the significance of the number assigned to indifference curves indicates different levels of satisfaction. Following are the features of the indifference curve:
1. Combining two goods providing the same utility is represented as an indifference curve.
2. The Indifference map represents the pattern of preference.
3. The higher the indifference curve, the higher is the level of satisfaction.
Why Indifference Curve is Ordinal Approach?
An indifference curve is ordinal because it deals with a consumer’s preference. It helps rank different bundles of goods in terms of their satisfaction to the consumer and its equilibrium.
Why does the Indifference Curve Analysis Approach Operate?
The indifference curve approach operates because it is based on the principle of utility maximization. This principle states that people will seek to maximize their utility, or satisfaction, by choosing the option that provides the most utility. The indifference curve approach uses this principle to identify the combination of goods that will benefit the consumer most.
What is Indifference Map and Its Properties?
Indifference map is a graphical representation of a set of indifference curves. Each curve represents a combination of two goods that the consumer is indifferent between.
The properties of an indifference map are:
1. The curves are downward sloping. 2. The curves are convex. 3. The curves do not intersect.