What is the Indifference Curve
An indifference curve is a graph that shows a combination of two goods that give a consumer equal satisfaction and utility, thereby making the consumer indifferent. Indifference curves are heuristic devices used in contemporary microeconomics to demonstrate consumer preference and the limitations of a budget. Later economists adopted the principles of indifference curves in the study of welfare economics.
BREAKING DOWN Indifference Curve
Standard indifference curve analysis operates on a simple two-dimensional graph. One kind of economic good is placed on each axis. Indifference curves are drawn based on the consumer's presumed indifference. If more resources become available, or if the consumer's income rises, higher indifference curves are possible, or curves that are farther away from the origin. Indifference curves do not cross each other and they never intersect.
For example, a young boy might be indifferent between possessing two comic books and one toy truck, or four toy trucks and one comic book.
The Principles and Characteristics of Indifference Curve Analysis
Indifference curves operate under many assumptions, especially that each indifference curve is convex to the origin and no two indifference curves ever intersect. Consumers are always assumed to be more satisfied with achieving bundles of goods on higher indifference curves. The basic analysis always operates under the transitive property of inequality — if a _ b and b _ c, then a _ c.
Many core principles of microeconomics appear in indifference curve analysis, including individual choice, marginal utility theory, income and substitution effects, and the subjective theory of value. The study of marginal rates of substitution and opportunity costs are emphasized. All other economic variables and possible complications are treated as stable or ignored unless placed on the indifference graph.
Most economic textbooks build upon indifference curves to introduce the optimal choice of goods for any consumer, based on that consumer's income. Classic analysis suggests that the optimal consumption bundle takes place at the point where a consumer's indifference curve is tangent with his/her budget constraint.
The slope of the indifference curve is known as the MRS, or the marginal rate of substitution. Stated simply, the MRS is the rate at which the consumer is willing to give up one good for another. So if she values apples, she will be slower to give them for oranges, and the slope will reflect that.
Criticisms and Complications
Indifference curves, like many aspects of contemporary economics, have been criticized for oversimplifying or making unrealistic assumptions about human action. One noteworthy criticism is that indifference is conceptually incompatible with economic action. The idea is every action necessarily demonstrates preference, not indifference, otherwise no action would take place.
Some worry that indifference curves erroneously lead economists to adopt cardinal utility functions; this criticism is unfounded since indifference curve analysis utilizes monotonic transformations to preserve ordinal rankings.
Other critics point out that it is theoretically possible to have concave indifference curves, or even circular curves that are either convex or concave to the origin at various points. Consumer preferences might also change between two different points in time, rendering specific indifference curves practically useless.