Indifference Curve Analysis

Indifference Curve Analysis

The indifference curve analysis is a graph showing the different combinations of two goods that report the same satisfaction to a person, and are preferred to other combinations.

When one arrives at two options that are indifferent to the individual, these two points that represent them are on the same indifference curve analysis. If you move along the curve in one direction, you are willing to accept more pens in exchange for fewer pencils. Also, if it moves in the other direction, it is willing to accept more pens and fewer pens. But at any point within that curve, reports the same level of satisfaction.

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The curve to which we refer reflects neither more nor less, preferences. In between pairs of goods and has no relation to the money or prices. Moreover, along the indifference curve each point has a different monetary value, but the degree of satisfaction is identical.

Example

It is plotted simply by asking an individual what combination of goods he prefers. For example: 10 pens and 5 pencils; 15 pens and 3 pens; Or 20 pens and 2 pens. This individual is indifferent to any of these three options. Note that, as one option increases, the other decreases. Following the example, if we start from the first basket (5 pencils and 10 pens), to get 5 more pens this individual will need 2 pencils. But in the next step, since only 3 pencils remain, if you want to remain indifferent, you must give 5 pens for a pencil.

Also, if an individual has the option to increase the number of pens without decreasing the number of pencils. This means that is a new indifference curve analysis, which reported higher profit than the last. So it is shown that there are traced infinite indifference curves forming that is known as contour map indifference.

On the other hand, the slope of the indifference curve measures the number of pens that the individual is willing to give up to get another pencil. The technical term for this slope is the marginal rate of substitution. So, that indicates the amount of good the individual wants to do without a change of one unit over another.

This ratio increases or decreases as the amount of goods the consumer already has. As we move along the indifference curve analysis, we increase the amount of one of the goods. Increasingly less of the other goods is necessary to compensate for the change. So, the slope of the curve becomes increasingly flat. This is known as the marginal ratio of decreasing substitution. 

Consumer Goods Relying On Budget

In this sense, we must not forget that consumer goods are bounded by their income or are subject to a budget constraint. In principle, the consumer can spend all his money on pens or pencils. However, the slope of this budget constraint measures the speed at which that consumer can compensate one good for another. Also, is given by the relative prices of both goods. That is, the budget constraint is determined both by consumer income as the relative prices of the goods.

Within the theory of consumer choice that investigates the behavior of an economic agent as a consumer of goods and services. There is an extremely useful tool to facilitate the analysis of the consequences of price variations. This tool is known as the indifference curves. Hence, providing the different combinations of goods that provide the same level of utility or satisfaction to an individual. This is the theme we developed today in our concepts of Economics. The indifference curve is plotted simply by asking an individual what combination of goods he prefers.

Example

10 hamburgers and 5 films; 15 burgers and 3 movies, 20 hamburgers and 2 movies, or 5 hamburgers and 7 movies. Note that as one option increases, the other decreases. When one arrives at two options that are indifferent to the individual. Then these two points that represent them are on the same indifference curve. If you move along the curve in one direction, you are willing to accept more movies in exchange for fewer hamburgers. Also, if you move in the other direction you are willing to accept more hamburgers and fewer movies. However, at any point within that curve reports the same level of satisfaction.

In Victorian times, philosophers and economists spoke of “utility” as an indicator of the general well-being of people. According to this idea it was natural to think that consumers made their decisions in order to maximize profitability. The problem is that these economists never described how to measure utility. Since, this is a subjective concept that does not report the same for another person. Therefore, the idea of utility as a measure of happiness was abandoned. Hence, the theory of consumer behavior was reformulated according to its preferences. The indifference curve shows the various combinations of two goods that reported the same satisfaction a person, and are preferred to other combinations.

Explanation

For example, all possible combinations of hamburgers or movies that report to the person the same level of utility or satisfaction. The indifference curve simply reflects the preferences between pairs of goods and has no relation to money or prices. Along with the indifference curve each point has a different monetary value, but its satisfaction is the same.

Also, if the individual has the option to increase the number of hamburgers without decreasing the number of films. This means that is now a new indifference curve , which reports more useful than the previous. Therefore, it is said that we can draw infinite indifference curves forming what is known as a map of indifference curves. This is the reason that indifference curves cannot intersect each other since the beginning of breaks have the same level of utility. The slope of the indifference curve measures the number of hamburgers that the individual is willing to give up to get another movie.

Marginal Decreasing Replacement

The technical term for this slope is the marginal rate of substitution. That indicates the amount of a fine to which the individual is willing to give up in exchange for a unit over the other. This ratio increases or decreases according to the quantity of the good that the consumer already has. As we move along the indifference curve. We increase the quantity of one of the goods, each time a smaller amount of the other is needed to compensate for the change. So, that the slope of the curve is made each time more flat. This is what is known as marginal decreasing replacement.

By definition, a person does not care about any of the points of an indifference curve given. However, rather found in the indifference curve as high as possible, because the farther the source, the higher the level of satisfaction. Although, what prevents you from achieving higher indifference curves is its budget constraint. In other words, as shown in the graph, the highest indifference curve that can reach a person is one who plays the budget constraint as tangent. At this point of tangency, both the curve and the line have the same slope.

Therefore, at the point of tangency, the slope of the Marginal Rate of Substitution has the same value. Same as the relation of the relative prices indicated by the budget constraint. So, we have a basic principle of consumer choice: individuals choose at the point where the marginal rate of substitution equals the relative price.

Budget Constraints

The budget constraint means that the assets of a consumer are bounded by their income. In this case, you can spend everything on hamburgers (intersection with the vertical axis). In addition to, all income on films (intersection with the horizontal axis). The slope of this budget constraint measures the speed that a consumer can compensate one good for another. That is given by the relative prices of both goods. That is why the budget constraint is determined both by the consumer’s income and by the relative prices of the goods. Though, it acquires more sense when we incorporate the analysis of indifference curves, which are incorporating consumer preferences.