Indifference curve is a diagrammatic presentation of the combination of two goods which gives the consumer the same level of satisfaction. It is a bearer of all such points which show diverse combinations of two commodities which gives the same level of satisfaction to the consumer. Each point on the Indifference curve indicates one of the all diverse combinations of two commodities. Each combination yields the same level of satisfaction among all the combinations.
Under indifference approach, in order to maximise satisfaction, consumer with his given budget will try to achieve the highest possible level of indifference curve.
Set of Indifference Curves IC1, IC2, and IC3 (i.e. Indifference Map) shows consumer’s scale of preferences between different combinations of good X and good Y.
LM is the Budget Line facing the consumer with given money income and prices of good X and good y. It is sure that consumer’s equilibrium will lie on some point on LM.
Consumer’s equilibrium will be achieved where Budget Line (LM) is tangent to highest possible indifference curve (here IC2). In other words, where Slope of Indifference Curve = Slope of Budget Line.
i.e., Marginal Rate of Substitution (XY) = Px/Py
Two conditions essential for consumer’s equilibrium are as follows:
(i)Budget Line must be tangent to Indifference Curve.
(ii)Indifference curve must be convex to the origin at the point of tangency.
Consumer will not/cannot achieve following situations:
(i)He will not choose point P and R on Budget Line (LM) because they will be on lower Indifference curve IC1 (i.e. less satisfaction). Choosing point Q puts him on a higher Indifference Curve IC3.
(ii)He cannot move on IC3 as it is beyond his income, i.e., he cannot buy any combination of good X and good Y on IC3.
Marginal Rate of Substitution
MRS of X and Y refers to the number of units of good Y that the consumer is willing to sacrifice for an additional unit of good X , so as to maintain same level of satisfaction.
Marginal Rate of Substitution (MRS of XY) = change in good Y /change in good X