CONSUMER BEHA\TIO-UR

Indifference Curve Analysis

.. In the ordinal utility theo0· Hicks. Allen. Pareto. etc. tried to explain that consumers ca nnot qu .:uit1 F-
utdity ,\·hat he den ves from consuming a specified unit of concerned commodity or service, but gi , en a s.:t ~f
alternati ves. consumers can rank their preferences or Call provide all ordering of their prefe rence pattern and
hence the ana lysis 1s called the Ordmal AnalYsis .
To discuss the ordinal analYsis. fi;st we have to define a rational consumer on the basis of several
axioms. which arc discussed belo\\ : · ·

I. Axiom of Completeness: This axiom states that all conunodity bundles can be compa red in tern1 s of
either indifference or preference. For example. for all A and B, either ARB or BRA ,\·here R indicates
the relation of preference or indifference.
2. Axiom of Transitivity : lllis axiom states that for all A. B and C, if ARB and BRC, then ARC.
3. Axiom of Selection : It means ,Yithin the visible set, the consumer tries to reach the most preferred
state.
cl Axiom of Dominance lft ,\O bundles A and Bare such that A has more of both the commodities than
B. then it is said that A dominates B T he axiom of dominance states that if A dominates B. consumer
" ·ill prefer A. This axiom is also kno\\n as the Axiom of Non-satiation or Axiom of Monotonic it\
5 Axiom of Continuity : This [Link] states that there exists a set of point on the boundar) cl 11 iding the:
commodity space into less prdernc:d and more preferred areas such that the poims on the bounda~ is
indi ffe rent to each other.
6. Axiom of Convexity of Preference This axiom represents the convexity of indifference curve>
Convex ity may be ·strong · or ·,, eak·. weak convexitY pem1its linea r indifference cun c but strong
con vexity does not. A curve is strictly convex to the origin if the line joining any t,\o points of the
curve lies to the right of rhe cur\'e.

Alternative Set of Assumptions

I . Utility is ordinally measurable: It means that different utility levels can be arranged in order. For
example, for two commodit\· bundles A and B. we can say that utility from A is greater than that from
B or utility from B is greater than that from A.
2. Different utility levels are interdependent: Utili~ obtained from any conunoditY depends not onh·
on the amount of that conunodity consumed, but also on the amount of other commodities consumed.
That is, u = f(q 1, qJ where q 1and q, are amount ofQ1 and Q, respectively.
3. Preference or Indifference: The consumer can order all the possible combinations of the t\\O

commodities in order of preference. For all A and B, consumer either prefers A to B or B to A or may
remain indifferent between them .
4. Transitivity between preference or indifference: For all A, B and C. if A is preferred to Band B is
preferred to C, then A is preferred to C.
5. The Law of Diminishing Marginal Rate of Substitution : This means that as the consumer gets
more unit of any commodi~·- the marginal rate of substitution (MRS) of that commodity decreases .
It is

to be noted here that. the marginal rate of substitution of x for y (MRS \ . y) measures the number of
units of y that must be sacrificed per unit of x, so as to get Salne level of utility.

Susanta Kumar Kara n: M o bile: 9 8312-60223 : E -mail: karan_susanta(alya [Link]

 L't 111,u111 c r I lch:1v 1P11r

6 Income of the buyers and the pr-ices of commodities are given: In the indifference cun c anal ysis
the consumers arc assumed to face a given le, cl of money income and gl\ en prices of the 1,, 0
commodities.

According to the abm e assumptions. ,,e must have a continuous. do,,m,ard sloping strictly convexed
indifference curve as shmrn in the following diagram .

__,,De/inilion : An inrufferencc cur\C is LhL: locus of rufferent combinations of two commodities (say. X and Y)
which yield same level of satisfaction or utility.
'f
Amount ofX An10unt ofY Rank of Utility
(units) (units)
10 8 U1
16 5 U2
20 4 U1

If the consumer is indifferent among LI 1. U2and U.1

i.e .. UI I U2 I U_1. the locus of all the above combinations give
us the indifference cun e As in the side h\· diagram . utilit\· at A
is idcntical in preference with that at B.

0 X
Fig. l !ndifli:rence ( ·,,,--ve
~ ' t - 'I

Properties of Indifference Cun·e

I . An indifference curve will be downward sloping: It means that to get the same le\el of urili~ . i.f the
consumer consumes more units of the eommodi~-. he must consume less of the other.

0 q,.~ 'I.; q.,

Fig 2. Omrmrnrd Sloping Demand Cwve
For example. as in the above diagram, utility level at A and at B is same. The consumer can
shift from A to B by increasing q 1 from qi° to q1 1and by decreasing q2 from qi° to q/

2. Two indifference curves cannot intersect or touch each other: Due to the axiom of dominance or
assumption of more is better, n,o indifference curves cannot intersect or touch each other.

As in JbO\·c
figure. for utility bd IC ,. A and B are indifferent and for IC 1_ A and C arc i11d1ftcrent. So. from the

Susnnla Kunwr Karan : Mobile· 98:; 12-6022:; : E-mail: karnn _s usanln a", ahoo .com
 C 1111 s 111111.:r l1cl ia v 10 111

axiom of transiti vity. B and C arc indifforcnl to each other. BuL the bundle ·c contains more of both
the commodities q1 and q2 - as a result C is preferred to B. This gives us a contradictory result. So. th1;
two indifference cun1es cannot intersect each other and similarh the\' cannot touch each other.

e 1 - - - - - -1--"""

IC
\ IC

r 0 b
b
As ab=bc. but de>ef, As ab=bc. but de<ef
MRS is decreasing . MRS is increasing.
Figure 3

3. Indifference curve must be convex to the origin: This property directh follO\\'S from the
assumpt ion of Dimi nishing Marginal Rate of Substitution. If the mdifforence curve is concave. then
the assumption must be violated. as the Marginal Rate of Substitution for a concave indifference
curve is increasing - individuals are \Yilling to sacrifice more and more units of commodity to get
additional units of other commodity.
4. An indifference curve passes through each point of the commodit) space i.e _ an indifference curve
is continuous.
5 An indifference curve above to another indifference curve provides higher level of satisfaction
or utility: It follO\\S from the axiom of dominance as a higher indifference curve contains more units
of both the commodities or at least one conunodity,

Budg~t Line: Consumer's Equilibrium

In the indifference curve approach, we assume that the consumer has a fixed amount of income (M)
v,-hich he spends in purchasing two commodities Q 1 and Q2, whose prices P 1 and P2 respectively are given .
The functional relationship between the money income, price of the commodities and the amount of
commodities purchased represent the budget line. The budget line is the locus of set of commodity bundles
that can be purchased if the entire money income is spent.
The budget equation can be written as M = p1q1 +p2q2 . .. .. (I) .
Since. M. p 1 and p 2 are constants, the above equation is a linear equation in q 1 and q 2 and it represents
different combinations of q 1 and q 2 \1·hich a consumer can purchase with his fixed nioncy income and given
pnces. However, the above equation can also be written as
M P1
q, =----qi
02 P, P2
A

D is not attainable as it lies above the budget line AB.

0
C is attainable but the consumer does not do it as here the
entire income is not spent.
M
pZ

o '.-- - - - - - - - - - - - ' - - QI -----------------------------

, Mobile: 9 8:; 12-6022:; : E-mail : karnn_susanta r1 •, ahoo .com
M
pl
 -I C' P11., umcr I k li:i, H11 ir

Figure 4

According to the above figure_ OA = and OB = M .

P: P1
M

Hence_ the slope of the budget line AB= - OA = = P1

OB M P:
P1
Application: Determination of Consumer's Equilibrium

Change in Budget Line

Case 1: Change in Money Income
Let us suppose the money income (M) changes, p 1 and p 2 remaining same. Then the budget line shifts
upward if M increases and dmmward if M decreases . Since, there is no change in slope of the budget line_ the
budget line shifts up\\ard or doml\\'ard parallely .
M M
Notc: If M rncreases. the intercept on v-axis OA= - increases . Agam. the intercept on ,-axis OB= -
P: pI

increases. BuL the slope of the budget line

P1 remains unchanged. The case ,,ill be reverse for dec rease in

M.
QZ
Al ,

0 B2 BI

Figure 5
Application: Derivation of Income Consumption Curve (ICC)

Case 2: Change in p 1• Mand pz remaining same

. P1 . . b I
If p 1 increases, M and p2 remaining same, the slope of the budget !me - - mcreases m a so ute
P,
tem1s . So, the budget line becomes steeper. but the intercept on -axis remain unchanged. Hence, the budget
line moves clockwise towards origin. On the other hand, if p 1 decreases, the slope of the budget line also
decreases in absolute tem1s and the
02 budget line moves anti-cloch,isc
A, from the origin .

Susanin Kunrnr K~ rnn_ susanta a ~·nhoo .con1

J
 C. p 11s u1111.:r Rc ha v inu r

Applicalion: Derivation of Price Consumption Curve (PCC) for QI

Case 3: Change in pz. Mand p 1 remaining same

P, decreases in absolute
If p2 increases. M and pr remaining same. the slope of the budget line
P,
terms . So. the budget line becomes flatter, but the intercept on x-axis remain unchanged . Hence. the budget
line moves anti-clockwise towards origin. Now. if p 2 decreases. the slope of the budget line rather increases in
absolute terms and the line moves clockwise from the origin

Q2

Al

0 QI

Application: Derivation of Price Consumption Curve (PCC) for Q2

Equilibrium of the Consumer

The objective of a rational individual is to maximise utility subject to budget constraint. l11at is. with
two commodities having fixed prices and with a gi ven income, the objective of the consumer is to select that
commodity bundle through which he gets the maximum amount of utility - the commodity bundle is tem1ed
as equilibrium bundle from which he gets equilibrium amount of both the conunodities .

The attainment of equilibrium of a consumer is represented in the following diagram.

Susanla Kumar Karan . Mobile : 98312-6 0223 . E-mail: kara.n_s usanla a'Yahoo .com
 l 'o 11 s 11 1111.: r lkha v 1111 ir

In the above diagram, we represent three indifference curves (IC 0, IC 1 and IC 2) and a budget line AB
on the same commodity space. The utility level represented by IC 2 lying above the budget line means it
cannot be reached by the consumer with his fixed income and given prices. The budget line just touches IC I at
E and cuts twice the !Co at C and D. The consumer can select any point on the budget line AB with his fixed
income. All the points in the budget line like C, D and .E are equally costly to the consumer. Since. a higher
indifference curve represents a higher utility IeveL the consumer must try to reach highest possible
indifforence curve remaining on the budget line AB This is possible when the budget line is just tangent to
one of these indifference curves . This happens. as in our above diagram. at the point E.

TI10ugh the points C and D are attainable to the consumer. he does not settle at either of these points.
The reason is that. from C substituting q 1 for q2. the consumer can attain higher indifference curve (IC 1).
Similarly, from point D, substituting q2 in place of q 1, he can again attain higher utility level. Hence, E is the
equilibrium point and Oq 1* and Oq 2* are the equilibrium amounts of Q 1 and Q2 respectively

Explai11ing the above equilibrium, ,Ye can 110\Y suggest h,o conditions for equilibrium as follows

Necessary Condition: The budget line should be just tangent to the indifference curve, i.e., the slope of the
p
indifference curve is equal to the slope of the budget line. It implies that MRS 1. 2 equal to f .
Sufficient Condition: The indifference curve must be convex to the origin. It suggests that MRS should be
diminishing

To get equilibrium. both the conditions must be satisfied.

Mathematical Representation

The equilibrium of the consumer can also be represented mathematically as follows .

The objective of the consumer is to maximise utility (u=f( q1,q2) l subject to the budget constraint
M=p1q1+p2q2. We apply Langrangian Multiplier method to solve this problem. The Langrangian function
becomes -

. . .(I) where ,,1 is the Langrangian multiplier.

The first order condition (FOC) of maximisation requires that -

Susanla Kumar Karan: Mobile : 983 12-60223 : E-mail. karnn_ s usan ta ii'[Link]