Indifference Curve Analysis

Topics: Consumer theory, Indifference curve, Budget constraint Pages: 4 (1281 words) Published: October 17, 2011
Spotlight on the theory

Indifference Curve Analysis

The aim of indifference curve analysis is to analyse how a rational consumer chooses between two goods. In other words, how the change in the wage rate will affect the choice between leisure time and work time. Indifference analysis combines two concepts; indifference curves and budget lines (constraints) The indifference curve

An indifference curve is a line that shows all the possible combinations of two goods between which a person is indifferent. In other words, it is a line that shows the consumption of different combinations of two goods that will give the same utility (satisfaction) to the person. For instance, in Figure 1 the indifference curve is I1. A person would receive the same utility (satisfaction) from consuming 4 hours of work and 6 hours of leisure, as they would if they consumed 7 hours of work and 3 hours of leisure. Figure 1: An indifference curve for work and leisure

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An important point is to remember that the use of an indifference curve does not try to put a physical measure onto how much utility a person receives. The shape of the indifference curve
Figure 1 highlights that the shape of the indifference curve is not a straight line. It is conventional to draw the curve as bowed. This is due to the concept of the diminishing marginal rate of substitution between the two goods. The marginal rate of substitution is the amount of one good (i.e. work) that has to be given up if the consumer is to obtain one extra unit of the other good (leisure). The equation is below

The marginal rate of substitution (MRS) = change in good X / change in good Y Using Figure 1, the marginal rate of substitution between point A and Point B is; MRS = -3 / 3 = -1 = 1
Note, the convention is to ignore the sign.
The reason why the marginal rate of substitution diminishes is due to the principle of diminishing marginal utility. Where this principle states that the more units of a good are consumed,...
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