Indifference Curve Analysis
The history of indifference curve(IC) can be traced backed to 1881, when Edgeworth had originally invented the indifference curve which was later on fully developed by British economist J.R. Hicks and R.G.D. Allen. An Indifference curve shows different combinations of two goods for which a consumer is indifferent. This concept is based on ordinal utility. The assumptions on which indifference curve analysis is based are consumers are rational; consumers are consistent in their selection, etc. We can understand the concept of indifference curve with the help of Indifference schedule, indifference curve and indifference map. The slope of indifference curve is marginal rate of substitution. It is the rate at which consumer substitute one good for another without altering the satisfaction from consumption. We also assume that consumer preferences are monotonic, i.e. consumer prefers the bundle which has more of at least one of the goods. The properties of Indifference curve are indifference curve slopes downward from left to right, it is convex to the origin, higher indifference curve yields higher satisfaction and two indifference curves never intersect each other.
Budget Line is the graphical presentation of all possible combinations of two goods that can be purchased at given prices with given income. Budget set shows all possible combinations of two goods that the consumer can buy with his income at prevailing market prices. The various properties of budget line are: it is a straight line; it has negative slope, etc.
Consumer’s equilibrium through IC analysis is based on the following assumptions: Consumer's income is constant, Consumer is rational, etc. Two main conditions of consumer’s equilibrium through indifference curve approach are:
Budget line/Price line should be tangent to the indifference curve.
Indifference curve should be convex to the point of origin.
The main similarities between marginal utility approach and IC approach are rationality of consumer, Diminishing marginal utility, etc.
Indifference curve approach is superior to marginal utility approach because: IC approach assumes ordinal utility, it abandons the assumption of independent utility, it provides an explanation to giffen goods and it does not assume marginal utility of money as constant.