Consumers Equilibrium Indifference Curve Approach

A consumer attains his equilibrium when he maximizes his total utility, given his income and the prices of the two commodities. We combine the indifference curve and the budget line to get consumer’s equilibrium.

Two condition is needed for the consumer to be in equilibrium.

1) MRS_xy = P_x/P_y

MRS_xy refers marginal rate of Substitution- It is the rate at which consumer is willing to substitute one good for another without changing the level of satisfaction.

For example: There are two commodities food(X) and clothing (Y).The marginal rate of Substitution X for Y is defined as the amount of X(food) the consumer is willing to give up to get one additional unit of Y(clothing) while maintaining the same level of satisfaction.

Given the amount of money which the consumer wants to spend on two commodities and given the prices of the two commodities, we can draw a budget line.

A budget line is a negatively sloping line as if a consumer wants to purchase more of one commodity, he has to sacrifice some amount of the other commodity. Its slope depends on the prices of the two commodities i.e. P_x/Py

Thus, the budget line shows the various combination which the consumer can afford to buy with his given budget and given prices of the two goods, the indifference map shows the consumer scale of preferences between various combinations of two goods.

Superiority of Indifference Curve Analysis Over Marginal Utility Analysis

1) Measurement of Utility :
The indifference approach is superior to the cardinal utility analysis (Marginal Utility) because it measures utility ordinally.
A consumer can compare the satisfaction (utility) derived from different goods or from different units of the same good.The ordinal method make this technique more realistic.

2) Study combination of two goods:
The cardinal utility approaches a single commodity analysis in which the utility of one commodity is regarded independent of the other.It does not speak of substitute or complementary goods, but group them as one commodity.

This assumption is less realistic as consumer buys not one but combination of goods at time.

The indifference curve technique is a two commodity model which discusses consumer behavior in case of substitutes, complementaries and related goods.

3) Marginal Utility of Money is not constant :

The utility analysis assumes constant marginal utility of money because it takes consumer income to be constant, but this is not realistic condition as with rise or fall in income the Marginal utility of money changes.

Properties of Indifference Curve

Indifference Curve analysis has rejected the concept of cardinal utility approach (Marginal Utility Analysis) and adopted the concept of ordinal utility.
This implies that consumer compare the utility (which goods or which combination of goods give him the same, more or less utility) derived from different goods. In this utility is not measured in quantitative terms but on the scale of preference.
Below shown is the Indifference Curve.

Properties of Indifference Curve :

indifference curve

1) Has a Negative Slope :

An indifference curve slopes downwards from left to right. This is due to the assumption of Marginal Rate of Substitution.

This means that as the consumer consumes more of one commodity say X, he must consume less quantity of the other say Y, then only  he will have the same level of satisfaction from different combinations of the two commodities.

As shown in the below graph, going to combination B from A, to get 1 additional unit of food,he has to give up 3 units of clothing. If unit of food is increased, without changing the unit of clothing than the consumer will prefer new combination to the previous one as the new combination gives him more utility.