# Indifference curve analysis and consumer equilibrium. Consumer’s Equilibrium: Interplay of Budget Line and Indifference Curve 2019-01-11

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## Consumer’s Equilibrium: Assumptions and Conditions X is priced at Rs. The line connecting the points E 1E 2 and E 3 is called the wage-offer curve. The second order condition must also be fulfilled. Thus, indifference curve is always convex neither concave nor straight. Previous Years Examination Questions 1 Mark Questions 1. Moreover, he will not stand below the budget line because there is an assumptions that the entire income is spent on two goods.

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## Indifference Curve Analysis: An Alternative Approach to Understanding Consumer Choice This assumption is called Transitivity. This means that the consumer always tries to maximize his satisfaction with limited resources. To be equivalent to h it must have less apple A. It is also called consumption possibility line. Assume that the price of commodity X decreases and the price of commodity Y remain unchanged. At the equilibrium point E 1 hours worked are L 1L and they increase to L 2L at the equilibrium point E 2, when his income rises to E 2L 2, from E1L1. In the first case the equilibrium of the consumer may be a corner solution, that is, a situation in which the consumer spends all his income on one commodity.

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## How to Derive Consumer's Equilibrium Through the Technique of Indifference Curve and Budget Line? She is thus willing to give up 2 days of skiing for a second day of horseback riding. Excise Duty: The indifference curve technique helps in considering the welfare implications of income tax vs. The budget line shows all the combinations of skiing and horseback riding Ms. Equilibrium of the Consumer : The equilibrium position of the consumer is shown in Fig. By joining points P and R, we can know all the possible combinations of two commodities X 1 and X 2, which can be purchased with Rs. Thus point E is not an equilibrium point.

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## Indifference Curves: Definition, Properties and Other Details Because all points along an indifference curve generate the same level of utility, economists say that a consumer is indifferent between them. Panel a of shows the original solution at point X, where Ms. It implies that the consumer still has the willingness to consume more of both the goods. The combination X 0Y 0 is an optimal choice point E for the consumer. Suppose the following combinations are equivalent: a 1 unit of apple and 4 units of orange b 2 units of apple and 3 units of orange c 3 units of apple and 2 units of orange d 4 units of apple and 1 unit of orange An Indifference Curve: These combinations are represented by small circles in Fig. Properties of the indifference curves: 1.

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## A Critical Evaluation of the Indifference Curve Analysis Thus, he gets benefit of Rs. He will buy the second unit also. Diminishing marginal rate of substitution: Preferences are ranked in terms of in­difference curves, which are assumed to be convex to the origin. Now she is on a higher indifference curve, E. An indifference map, in other words, is comprised of a set of indifference curves. If the benefit to Ms. Suppose that in the beginning A possesses O bY b units of good Y and O b Х b units of good X.

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## A Critical Evaluation of the Indifference Curve Analysis An indifference curve has a negative slope, which denotes that if the quantity of one commodity y decreases, the quantity of the other x must increase, if the consumer is to stay on the same level of satisfaction. To show which combination of two goods, X and Y, the consumer will decide to buy and will be in equilibrium position, his indifference map and budget line are brought together. Behavioural economics is discovering that consumers are not rational. For instance, prices of commodities. However, there are many more factors that influence consumer choice. Here, indifference curve B is preferred to curve A, which is preferred to curve C. Point A lies on both I 1, and I 2.

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## The Uses or Application of Indifference Curve Analysis A positive sign of the cross-elasticity implies that x and y are substitutes; a negative sign implies that the commodities are complements. Corresponding to point F , we derive the point F 1 in figure B. And, indifference curve theory assumes that the consumer has not reached the point of satiety. Marginal rate of substitution: It is the rate at which a consumer is willing to sacrifice one commodity for an extra unit of another commodity without affecting his total satisfaction. The consumer has a money income V , which he spends on the available commodities.

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## A Critical Evaluation of the Indifference Curve Analysis Thus, this theory is also known as ordinal approach. In the case of complementary goods, indifference-curves analysis breaks down, since there is no possibility of substitution between the commodities. Thus I 3 is superior to I 2,1 2 to I, and so on. Mathematical derivation of the equilibrium: Given the market prices and his income, the consumer aims at the maximization of his utility. He put this unpleasant experience to good use by testing a number of economic theories there.

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## 4 Assumptions to Explain the Equilibrium of the Consumer (with curve diagram) From this reasoning we can conclude that the equili­brium position of the consumer is at the point where the Consumption Possibility Line is the tangent of an Indifference Curve. Therefore, the last conditions are that at the point of equilibrium, the marginal rate of substitution of X for Y must be falling for equilibrium to be stable. But at what level will exchange take place? The point of maximum satisfaction is achieved by studying indifference map and budget line together. Hence, at the position of equilibrium, the ratio between the prices of the two goods just equals the ratio of substitution between them. Individual A would, however, be at a disadvantage for he is on the lowest indifference curve I 1a.

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## Consumer’s Equilibrium: Assumptions and Conditions The concept of indifference curve analysis was first propounded by British economist Francis Ysidro Edgeworth and was put into use by Italian economist Vilfredo Pareto during the early 20 th century. Combination of goods represented by R costs him the same as the combination Q. This is called the Principle of Diminishing Marginal Substitutability. The marginal utility of X therefore, decreases while that of Y increases. Higher indifference curve represents higher level of satisfaction Higher the indifference curves, higher will be the level of satisfaction.

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