Q.What do you understand by Indifference curve? Explain Consumer's Equilibrium with the help of Indifference curves.
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Start your 14-day free trial to unlock the full solution →An indifference curve shows equal-satisfaction combinations of two goods; the consumer is in equilibrium where the budget line is tangent to the highest attainable indifference curve, with MRS = price ratio and the curve convex to the origin.
Indifference Curve:
An indifference curve is the locus of all those combinations of two goods (say X and Y) which give the consumer the same level of total satisfaction. Since each combination on the curve yields equal satisfaction, the consumer is 'indifferent' among them. A set of such curves is called an indifference map, where a higher curve represents a higher level of satisfaction.
Properties of indifference curves: (i) they slope downward from left to right; (ii) they are convex to the origin because of the diminishing Marginal Rate of Substitution (MRS); (iii) higher indifference curves show higher satisfaction; and (iv) two indifference curves never intersect.
The Marginal Rate of Substitution (MRS) is the rate at which the consumer is willing to give up units of good Y to get one more unit of good X, keeping satisfaction constant; MRS diminishes as more of X is obtained.
Consumer's Equilibrium using indifference curves:
Consumer's equilibrium is the situation in which the consumer, with a given income and given prices, buys that combination of the two goods which gives maximum satisfaction, and has no tendency to change it.
Two tools are used:
- The indifference map — showing the consumer's preferences; the consumer wishes to reach the highest possible curve.
- The budget line (price line) — showing all combinations of X and Y that can be bought by spending the whole of the given income at given prices; its slope is the price ratio Px/Py. The consumer tries to reach the highest indifference curve that the budget line allows. This is possible only at the point where the budget line is tangent to (just touches) an indifference curve — the point of tangency (say E). At this point: Condition 1 (necessary): slope of the indifference curve = slope of the budget line, i.e. MRS of X for Y = Px/Py. Condition 2 (sufficient): at the point of tangency the indifference curve must be convex to the origin, i.e. MRS must be falling. …
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