Indifference Curve Analysis

1267 WordsOct 3, 20116 Pages
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…show more content…
Figure 4: An increase in consumer income [pic] If consumer income fell then there would be a corresponding parallel shift to the left to represent a fall in the potential combinations of the two goods that can be purchased. A change in the price of a good and the budget line If income is held constant, and the price of one of the goods changes then the slope of the curve will change. In other words, the curve will pivot. This is illustrated in Figure 5. Figure 5: A change in price [pic] The reduction of the price of good x from £2 to £1 means that on a fixed budget of £60, the consumer could purchase a maximum of 60 units, as opposed to 30. Note that the price of good y has remained fixed, hence the maximum point for good y will remain fixed. Indifference analysis combines two concepts; indifference curves and budget lines (constraints) The first stage is to impose the indifference curve and the budget line to identify the consumption point between two goods that a rational consumer with a given budget would purchase. The optimum consumption point is illustrated on Figure 6. Figure 6: The optimum consumption point [pic] A rational, maximising consumer would prefer to be on the highest possible indifference curve given their budget constraint. This point occurs where the indifference curve touches (is tangential to) the budget line. In the case of Figure 6, the optimum consumption point occurs at point A on indifference curve I3. Indifference analysis can
Open Document