Indifference Curve

Imagine you were asked to divide your money between clothes and food. How many units of food and how many units of clothes would you choose to buy? Which combinations of food and clothing would give you the same level of satisfaction? Is that even possible? According to the theory behind the indifference curves, that's quite possible! Want to find out how indifference curves work and what they say about your preferences? Keep scrolling!

Indifference Curve Definition

The indifference curve definition refers to the graph which depicts all the possible combinations of market baskets that provide a customer with the same level of satisfaction. A consumer does not prefer a market basket over any other that lies on the same indifference curve. Hence, the consumer is said to be indifferent between choosing one basket or the other.

It's also important to note that the indifference curve is built on the individual's taste. It is upon the individual's preference and taste to decide which market baskets give them the same utility.

If a consumer is satisfied with either of the two bundles, then we say that they are indifferent between the two bundles since both satisfy the customer to the same degree.

Fig. 1 - Indifference curve of a person choosing between food and clothing

Figure 1 shows the indifference curve of a person choosing between food and clothing. All the points along the indifference curve represent choices between food units and clothing units the individual makes. It is important to note that the individual is indifferent between all the points along the indifference curve.

Fig 2. - Indifference map

Figure 2 shows the indifference map, which consists of multiple indifference curves.

Any market basket which lies on I₃ is preferred to any basket that lies on I₂ and I₁. The higher indifference curves are preferred to lower ones. The consumer receives the same level of utility from any combination of market baskets that belongs to I₃, but he will always choose them and prefer them more than the market baskets belonging to I₂ and I₁.

The Slope of the Indifference Curve

The slope of the indifference curve is the marginal rate of substitution.

In other words, the marginal rate of substitution measures how much of good 1 an individual is willing to give away for the consumption of good 2 along the indifference curve. That means that regardless of the amount of consumption the individual is ready to give away, they remain equally satisfied along the indifference curve.

Fig. 3 - Indifference curve of an individual choosing between the two goods

Figure 3 shows the indifference curve of an individual that is choosing between Coffee and Pepsi while being equally satisfied at each point on the indifference curve. At point 1, the individual decides to consume ten units of Coffee and one unit of Pepsi. At point 2, the individual is happy to consume two units of Pepsi and five units of Coffee.

Notice that when the individual moved from point 1 to point 2, they lowered the consumption of Coffee from ten to five and increased the consumption of Pepsi from one to two units. That means they gave away five units of Coffee for an additional unit of Pepsi. This implies that their marginal rate of substitution is equal to five Coffees per Pepsi.

Fig. 4 - Marginal rate of substitution between Pepsi and Coffee

Figure 4 shows the marginal rate of substitution at each point of the indifference curve for an individual choosing between Coffee and Pepsi. Notice that the marginal rate of substitution decreases as the individual increases their consumption of Pepsi. Initially, they gave up five units of Coffee for a Pepsi, then three units of Coffee, and then only one unit of Coffee.

The diminishing marginal rate of substitution is the reason why the indifference curve is convex (bowed inward). Being convex means that an individual will initially give away a higher amount of good 2 to consume an additional amount of good 1. However, at some point, this begins to drop, and the rate at which the consumer replaces one good for the other drops, which makes the indifference curve convex.

Indifference Curve Properties and Assumptions

There are four key properties of indifference curves.

1. Higher indifference curves are preferred to lower ones. Higher indifference curves are preferred to lower ones because at higher indifference curves, there is more consumption taking place, and individuals prefer to consume more than less.
2. Indifference curves are downward sloping. The rate at which a customer is ready to exchange one item for another may be seen reflected in the slope of an indifference curve. If the amount of one product is decreased, the quantity of the other good must increase for the customer to experience the same level of satisfaction. Hence, it is downward sloping.
3. Indifference curves do not intersect. Two different indifference curves do not intersect. Imagine that there are two different indifference curves. Normally, one would be higher than the other. Remember that an individual is happy to consume any combination on an indifference curve; however, they will always prefer higher indifference curves to lower ones. When two indifference curves intersect, you have one market basket in common for both. The lower indifference curve has market basket A and market basket B. And on the higher indifference curve are market basket B and market basket C. That means that the consumer is equally satisfied between the consumption of market basket A and market basket C. However, that is not true, as the higher indifference curves are preferred to lower ones, which is why they can't intersect.
4. Indifference curves are convex. The indifference curves are bowed inward due to the diminishing marginal rate of substitution. In particular, the indifference curves are bent inward because individuals are more eager to give away items they have an excess of and less willing to trade away goods of which they have little.

The main properties of the indifference curve are based on the basic assumptions of consumer choice theory. These basic assumptions reveal why an individual prefers one market basket over another. The main assumptions of the consumer choice theory are Completeness, Transitivity, and More is better than less.

• Completeness refers to the preferences of individuals being complete. That means the consumer can rank the market baskets and choose between them.
• Transitivity. Transitivity means that if an individual chooses market basket one over market basket two, and market basket two is preferred over market basket three, then market basket one is also preferred to market basket three.
• More is better than less. The market basket with more goods is always preferred to those with fewer goods.

Perfect Substitutes Indifference Curve

The indifference curve of perfect substitutes is linear. This means that the marginal rate of substitution is equal to one. A consumer gives away only one unit of good 2 in exchange for a unit of good 1 at all points along the indifference curve.

The shape of an indifference curve reveals the degree to which consumers are prepared to exchange one product for another. The indifference curves are less convex when the commodities may be easily substituted for one another; on the other hand, when it is difficult to replace one commodity for another, the indifference curves are more convex.

Fig. 5 - Perfect substitutes indifference curve

Figure 5 shows the perfect substitutes indifference curve for an individual choosing between apple juice and peach juice. These two goods are perfect substitutes for the individual as they are utterly indifferent between having a glass of apple juice or peach juice.

In such a case, the marginal rate of substitution between apple juice and peach juice is equal to 1. This means that an individual will always be willing to give away one glass of peach juice for an additional glass of apple juice while always being happy about it.

Perfect Complements Indifference Curve

Perfect complements' indifference curves are right-angled.

To illustrate the graph of perfect complements indifference curves, think about a left shoe and a right shoe.

Fig. 6 - Perfect complements indifference curve

Figure 6 shows the indifference curve of an individual who consumes right shoes and left shoes. For the individual, the right shoe and the left shoe are complements because only one shoe will not increase utility unless the shoe is matched with the other shoe.

In such a case, the marginal rate of substitution of the right shoe is zero when there are more right shoes than left ones. The marginal rate of substitution is infinite when there are more left shoes than right. That's because the individual needs the pairing shoe to achieve any given level of utility in the case of perfect complements.