CONSUMER EQUILIBRIUM THROUGH INDIFFERENCE CURVE APPROACH

The indifference curve approach was given by Hicks and is based on ordinal measure of utility i.e. denoting ranks to levels of satisfaction (like first, second, third etc).  Hicks assumed that the utility derived from the consumption of a commodity can’t be expressed numerically in terms of utils but in levels of satisfaction. He gave some important concepts to describe his indifference curve analysis which are:

BUNDLE may be defined as the combination of amount of two goods.

BUDGET SET is the various sets of bundles or combinations of two goods which a consumer can purchase using his given income.

BUDGET LINE represents all those combinations of two goods which a consumer can purchase with his entire income. This is also called PRICE LINE.

The equation of budget line is :

P1X1 + P2X2 = M

Where, P1 stands for price of good 1

                  Q1 stands for quantity of good 1

            P2 stands for price of good 2

                  Q2 stands for quantity of good 2

                           M stands for income of the consumer

INDIFFERENCE CURVE represents all those combinations of two goods that give equal level of satisfaction to a consumer.

A consumer is said to be in equilibrium at a point where the indifference curve is tangent to the budget line. In other words, the slope of the indifference curve must be equal to the slope of budget line at the point of attainment of equilibrium.           

the above figure, the consumer attains equilibrium at point C where the slope of budget line is equal to the slope of the indifference curve.

The consumer does prefer IC1 since the combinations represented on this indifference curve give him lesser level of satisfaction and are inferior to the ones on IC2. However, IC3represents those bundles which are not affordable to him. Hence optimum bundle is located at point C on the IC2 which is the highest attainable indifference curve.