According to Prof. Left witch, “A single indifference curve shows the different combination of X and Y goods that yield equal satisfaction to the consumer.” Indifference curves slope negatively and are convex to the origin. Higher indifference curves represent higher level of satisfaction. Indifference curve technique is based on preference hypothesis. It assumes that the consumer is rational and consistent in his choice of basket of goods. Rationality means he wants to maximize his satisfaction at a given level of money income and at given prices of goods.
Consumer’s equilibrium:The aim of the consumer is to allocate his money between different goods in such a way that he gets maximum satisfaction. According to indifference curves analysis a consumer will be in equilibrium position when he purchases such a combination of goods that yield maximum satisfaction in a given price-income situation. For the consumer to be in equilibrium, the following two conditions must be satisfied: (i) Price line (budget line) must be tangent to the indifference. It means marginal rate of substitution (MRSxy) between two goods (X and Y) should be equal to their price ratio (Px/Py), that, is, MRS xy = Px/ Py. (ii) The MRSxy must be diminishing, i.e.
, the indifference curve should be convex to the origin at the point of equilibrium. The price line AB is tangent to the indifference IC3 at point P. All other points lying on the price line are on lower indifference curve.
Therefore, the consumer will be in equilibrium at point P because this gives maximum satisfaction to the consumer. At point P the slope of price line (Px/Py ) and the slope of the indifference (MRSxy) are equal, i.e. at point P, MRSxy = Px/Py. At point S and T, MRSxy Px/Py. At point P, the indifference curve IC3 is convex to the origin. Therefore, the consumer will be in equilibrium when he purchases P combination (OQ of X goods and QP of Y goods) of goods X and Y.
The consumer’s equilibrium will change in the following situations : 1. When money income changes, prices of goods remaining unchanged (income effect). 2. When price of one goods changes while money income and price of the other goods remaining unchanged (price effect). 3. When relative prices of goods changes and real income reaming the same (substitution effect).