Topic 5: IC & BL

• Indifference curve analysis does not attempt to measure satisfaction in cardinal numbers but is based on ranking consumer satisfaction in order of preferences using ordinal numbers.
• An indifference curve is a graphical representation showing different combinations of commodities which yield to the consumer the same level of satisfaction.
• Consumers may not be satisfied with their optimal consumption choice.
• Consumers may not have perfect knowledge.
• Consumers are not always rational.
• The optimal consumption choice may not in practice give consumers maximum satisfaction.
• Under indifference curve analysis, the consumer considers all possible combinations of goods and service which he/she can afford and subsequently chooses the combination which is the most preferred.
• The choice framework of indifference curves and the consumer budget line represents the consumer's preferences.
• On the curve, point ABCD represent the consumption bundles.
• On the graph, Point A bundle comprises 4 units of good X and 20 units of good Y.
• Point B bundle comprises 8 units of goods x and 10 units of good y.
• The consumer would have the same preference for either combination A or B.
• The same thing applies to all the other consumption bundles along this curve such as C and D.
• There are two goods X and Y in indifference curve analysis.
• The consumer acts rationally so as to maximise satisfaction in indifference curve analysis.
• Any combination of both goods yield the same level of satisfaction in indifference curve analysis.
• The consumer’s tastes, habits and income remain the same in indifference curve analysis.
• The rate of exchange between both goods is called the marginal rate of substitution in indifference curve analysis.
• An indifference map shows a whole set of indifference curves.
• The further away a particular curve is from the origin the higher the level of satisfaction it represents in an indifference map.
• Total price effect consists of income effect and substitution effect.
• By drawing a parallel budget line M2N2, we are eliminating the income effect.
• When price of good X (Px)falls, the consumer tends to increase consumption of good X as a result of substitution effect.
• When good X is a Giffen good then also substitution and income effects work in opposite directions.
• The magnitude of change in units of good X on account of the substitution effect is less than the income effect.
• Individual indifference curve analysis demonstrates the logics of rational consumer choice, the derivation of the individual indifference curve and the income and substitution effect without having to measure utility.
• The final price effect is positive when a good is normal.
• The price effect, the final outcome, is therefore negative.
• Income effect here is negative.
• The price effect then depends on relative magnitude of the two effects.
• When good X is an inferior good, then the substitution and income effects work in opposite directions.
• The final price effect is positive for inferior goods, as change in the consumption of good X as a result of the substitution effect is greater than the income effect.
• The consumer again moves to another equilibrium point E2.
• Consumer choice may be influenced by advertisement.
• At E2, the quantity demanded of commodity X increases by X1X 3.
• The consumer tends to increase consumption of Good X with fall in its price.
• Indifference curves are an infinite number of indifference curves on the same set of axes; collectively these are called indifference map.
• Indifference curves are downward sloping which means you have to give up more of a commodity to obtain more of another commodity.
• The slope measures the rate at which the customer is willing to substitute good x for good y so as to leave satisfaction unchanged in indifference curve analysis.
• Plot the budget lines when income is assumed to be $10 and also when income increases to $20.