Indifference analysis combines two concepts; indifference curves and budget lines.
The first stage is to impose the indifference curve and the budget line to identify the consumption point between two goods that a rational consumer with a given budget would purchase.
The optimum consumption point is illustrated in the following figure.
• The tangency point of indifference Map and budget line gives us the
equilibrium position E.
• Indifference map intersects the budget line at 3 points x , E and Z
• x and z lie on the lower indifference curve than E lies on and hence gives
lesser utility than E. So, E is the The optimum consumption point.
Consumer Behaviour - Aim of a consumer is to get maximum satisfaction from the limited resources.
Budget Line- Budget line tell us all the combinations of 2 goods that can be purchased with a given income.
Indifference Curve - An indifference curve is a locus of combination of points that shows all the possible combinations of two goods which give him the same level of satisfaction
Now in the above diagram, we have 5 points X,Y,Z,E and D.
-Point D lies outside the budget of the consumer, hence can’t be achieved.
-Point Y lies inside the budget, but it would leave some of the money unspent.So, we won’t go for it as it wont give the consumer maximum satisfaction.
-With a limited income,X , Z and E can be achieved, but what would the consumer choose is the question here.
- Points x and z lie on the lower indifference curve than the point E lies on and hence gives lesser utility than E. So, E is the The optimum consumption point and the consumer will choose E.
- the point of tangency of indifference curve and budget line gives us the equilibrium position for the consumer i.e. attaing maximum satisfaction from the limited income.