Indifference Curve Approach: Ordinal Utility, Nations of Preference and Assumptions

Indifference curve method has been evolved to supersede the cardinal utility analysis of demand.

The indifference curve method seeks to derive all rules and laws about consumer’s demand that are derivable from the cardinal utility analysis.

At the same time the inventors and supporters of new method contend that their analysis is based on fewer and more reasonable assumptions. The indifference curve analysis has however, retained some of the assumptions of Marshall’s cardinal utility analysis.

Thus, the ‘indifference curve approach, like the old cardinal utility approach, assumes that the consumer possesses ‘complete information’ about all the relevant aspects of economic environment in which he finds himself. For example, the prices of goods, the markets in which they are available the satisfaction to be obtained from them etc., are all known to the consumer.

Further it is assumed that the consumer acts rationally in the sense that, given the prices of goods and the money income, he will choose the combination from among the various possible combinations that gives him maximum satisfaction.

Moreover, the assumption of continuity has also been retained by Hicks-Allen indifference curve method. Continuity assumption means that the consumers are capable of ordering or ranking all conceivable combinations of goods according to the satisfaction they yield.

Ordinal Utility:

The fundamental approach of indifference curve analysis is that it has abandoned the concept of cardinal utility and instead has adopted the concept of ordinal utility. According to the supporters of the indifference curves theory, utility is a psychic entity and it cannot therefore be measured in quantitative cardinal terms. In other words, utility being a psychological feeling is not quantifiable.

The concept of cardinal utility, according to the exponents of the indifference curve theory, is therefore untenable. On the other hand, the assumption of ordinal utility, according to them, is quite reasonable and realistic. The ordinal utility implies that the consumer is capable of simply comparing the different levels of satisfaction’.

In other words, according to the ordinal utility hypothesis, while the consumer may not be able to indicate the exact amounts of utilities that he derives from commodities or any combination of them, but he is capable of judging whether the satisfaction obtained from a good or a combination of goods is equal to, lower than, or higher than another.

Notions of Preference and Indifference:

For deriving the theory of consumer’s behaviour, it is sufficient to assume that the consumer is able to rank his preferences consistently. Thus, the basis of indifference curve analysis of demand is the preference-indifference hypothesis. This means that if the consumer is presented with a number of various combinations of goods, he can order or rank them according to his ‘scale of preferences.

If the various combinations are marked A, B, C, D, E, etc. the consumer can tell whether he prefers to B, or B to or is indifferent between them. Similarly, he can indicate his preference or indifference between any other pair of combinations. The concept of ordinal utility implies that the consumer cannot go beyond stating his preference or indifference.

In other words, if a consumer happens to prefer to B, he cannot tell by how much he prefers to B. Thus, under ordinal utility hypothesis, the consumer cannot tell the ‘quantitative differences between various levels of satisfaction; he can simply compare them ‘qualitatively’, that is, he can merely judge whether one level of satisfaction is higher than, lower than or equal to another.

Further, according to the supporters of indifference-curve method, by ‘how much’ one combination of goods is preferred to another is not even needed for deriving laws concerning consumer’s behaviour. It is sufficient to assume that the consumer is able to tell whether one combination of goods gives him greater, equal, or less satisfaction than another.

It may be noted that the consumer formulates his scale of preferences independently of the market prices of goods keeping in view only the satisfaction which he hopes to get from various combinations of goods. In consumer’s scale of preferences some combinations will occupy the same place, i.e., the consumer will be indifferent among them. Combinations occupying a higher place in his scale will be preferred to the combinations occupying lower places in the scale.

Moreover, the indifference curve analysis assumes that the preference and indifference relations are ‘transitive. The transitivity of preferences or indifference relations means that if a consumer prefers A to B, and B to C, then he will also prefer A to C and, likewise, if he is indifferent between and B, and between B and C, then he will also be indifferent between A and C.

Assumptions of Indifferent Curve Analysis:

Before explainingthe properties or attributes which the indifference curves normally possess,it will be useful if we first mention the assumptions about the behaviour of the consumer which are generally made in indifference curve analysis.

1. More of a commodity is better than less:

It is assumed that the consumer will always prefer a larger amount of a good to a smaller amount of that good, provided that the other goods at his disposal remains unchanged. This is a very reasonable assumption implies that the consumer is not over-supplied with any good.

When a consumer is over-supplied or over-satiated with one good, he will prefer a smaller quantity of that good to its larger quantity. It is thus assumed that the consumer has not yet reached the point of satiety in consumption of any good. This assumption is therefore known as non-satiety assumption.

2. Preferences or indifferences of a consumer are transitive:

Suppose there are three combinations of two goods A B and C. If the consumer is indifferent between and B and also between B and C, it is then assumed that he will be indifferent between and C too. This implies that consumer s tastes are quite consistent. This assumption is known as assumption of transitivity.

3. Diminishing marginal rate of substitution:

In indifference curve analysis the principle of diminishing marginal rate of substitution is assumed. In other words, it is assumed that as more unit of X are substituted for Y, the consumer will be willing to give up fewer and fewer units of Y for each additional unit of X, or when more and more of Y is substituted for X, he will be willing to give up successively fewer and fewer units of X for each additional unit of Y.

This rule about consumer’s behaviour is described as the principle of diminishing marginal rate of substitution. This principle follows as a matter of logical necessity from the assumption that particular wants are satiable and that various goods are not perfect substitutes for one another.