INDIFFERENCE CURVE ANALYSIS : ORDINAL UTILITY APPROACH

Assumptions
Rational behavior of the consumer Utility is ordinal Diminishing marginal rate of substitution Consistency in choice Transitivity in choice making Goods consumed are substitutable

Definition :
An indifference curve is the locus of points representing all the different combinations of two goods which yield equal level of utility to the consumer.

Indifference Schedule :
Indifference schedule is a list of various combinations of commodities which are equally satisfactory to the consumer concerned.

Indifference Schedule:
Combinations Apples Mangoes

A B

15 11

1 2

C
D

8
6

3
4

Indifference curve shows all possible combinations of apples and mangoes between which a person is indifferent. Point A shows consumption bundle consisting of 15 apples and one mango. Moving from point A to Point B, we are willing to give up 4 apples to get a second mango (total utility is the same at points A and B).
16 A 14 12
Apples

B C D E IC

10 8 6 4 2 0 0 1 2 3 Mangoes 4 5 6

Indifference Map :
A graph showing a whole set of indifference curves is called an indifference map. All points on the same curve give equal level of satisfaction.

25 20 15 10 IC3 5 0 0 1 2 Mangoes 3 4 5 IC2 IC1

Apples

Assumptions of IC.
1. Not measurable quantitatively :Since utility is a psychological phenomenon, it cannot be measured quantitatively. 2. Levels of satisfaction comparable :The consumer can compare the different levels of satisfaction. But he/she cannot express the utility in particular quantity.

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3. Transitivity : For any three bundles, A, B, and C, if A>B and B>C, then A>C (Baye, p. 121). Transitivity implies that indifference curves do no intersect one another and rules out the possibility that the consumer can not make a decision (Baye, 2006).

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If a consumers preference is not transitive then he or she would not be able to make a decision regarding what good to consumer. For example, Nick likes three goods: hot dogs, hamburgers, and ham sandwiches. In his mind, he prefers hot dogs over hamburger, hamburgers over sandwiches, and sandwiches over hotdogs. Because of his preferences are not transitive, he is unable to choose his best or favorite good.

4. More is better.
If bundle A has equal amounts of Jolly Ranchers and Snickers as bundle B and A has more Snickers than bundle B, bundle A will be preferred by the consumer. In graphical terms, as points and indifference curves move up and to the right, consumers view the bundle or curve as being better or more attractive. As points move down and to the left, it begins to lose its attractiveness from the consumer(Baye, 2006). This is illustrated in the graph below.

Diminishing Marginal Utility

The law of diminishing marginal utility says, while keeping consumption of other products constant - there is a decline in the marginal utility that person derives from consuming each additional unit of that product (Investopedia, 2007). Marginal utility can also be described as the level of satisfaction or enjoyment a one gets out of consuming a good.

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A great example of diminishing marginal utility can be seen with all you can eat buffets. The first plate a consumer eats will give him or her the highest utility or satisfaction, but as the consumer goes back to the buffet a second and third time, his or her utility will continue to drop. Eventually the consumer will not receive any utility from the good because his or her hunger has been satisfied (Investopedia, 2007).