‘Higher indifference curve represents a higher level of satisfaction to the consumer'. Explain the statement, also state the underlying assumption related to this property of the indifference curve.

OR

A consumer consumes two goods X and Y. Explain what will happen if MUx/Px is greater than MUy/Py?

Indifference curve (IC) analysis is the main component of ordinal utility analysis which is based on the ability of the consumer merely to rank their utilities. IC shows the locus of the combination of two goods that gives the same level of satisfaction to the consumer. The consumer is indifferent between any points throughout the IC. Hence it is also called iso-utility curve.

An important property of IC is that a higher IC depicts a higher level of satisfaction. A consumer always prefers more commodities compared to lesser commodities. A higher IC would imply a higher basket of good available for consumption by the consumers. Thus, a consumer will always prefer the highest attainable IC which gives them more satisfaction according to the budget constraint. Thus, the higher the IC in the IC map, more will be the level of consumer satisfaction. IC3 will give the consumer more satisfaction than IC1 as IC1 is a lower IC compared to IC3.

OR

A consumer is any individual who tries to maximise their satisfaction within the constraints imposed by the budget. A consumer may have unlimited wants. But all the wants cannot be completely satisfied. The consumer will decide how much quantity they have to purchase based on the marginal utility derived from the good and the price of the good.

A consumer will be in equilibrium when the total utility is maximised by spending the limited income on different goods. The utility is the want-satisfying capacity of any commodity. The consumer will maximise the utility when the equal utility is derived from the last unit of money spent on each commodity. This will make the consumer achieve equilibrium.

The purchasing behaviour of the consumer is determined by two basic factors. They are:

• The marginal utility of the goods

• Price of the goods

The consumer will maximise the utility and make the purchasing decision by considering the proportion of the marginal utility and prices of different goods. Thus the consumer will make the decision based on the marginal utility of the good with its price, i.e. MU/P ratio. Marginal utility is the addition made to the total utility when an additional unit of a good is consumed. The consumer will purchase more of the commodity when the marginal utility derived from it is higher than the price.

In the case of two commodities, the consumer will be in equilibrium when MUx/Px=MUy/Py. Thus the consumer will allocate the expenditure in such a way that the utility derived from the last rupee spent on each commodity is the same. The consumer will purchase the commodity for which the MU/P ratio is higher as this will give more satisfaction. If the consumer is consuming good X and good Y, and the MUx/Px>MUy/Py, the consumer will increase the consumption of good X and reduce the consumption of good Y as good X is giving higher utility. As the quantity of good X rises, the utility gained from each additional unit of consumption of good X falls. Consequently the consumption and the utility from the increased consumption of good Y increases. The consumer will be in equilibrium when MUx/Px=MUy/Py.