Theory of Ordinal Utility/
Indifference Curve Analysis:
Definition and Explanation:
The indifference curve indicates the various combinations of two goods which yield equal satisfaction to the consumer. By definition:
"An indifference curve shows all the various combinations of two goods that give an equal amount of satisfaction to a consumer".
The indifference curve analysis approach was first introduced by Slustsky, a Russian Economist in 1915. Later it was developed by J.R. Hicks and R.G.D. Allen in the year 1928.
These economist are the of view that it is wrong to base the theory of consumption on two assumptions:
(i) That there is only one commodity which a person will buy at one time.
(ii) The utility can be measured.
Their point of view is that utility is purely subjective and is immeasurable. Moreover an individual is interested in a combination of related goods and in the purchase of one commodity at one time. So they base the theory of consumption on the scale of preference and the ordinal ranks or orders his preferences.
The ordinal utility theory or the indifference curve analysis is based on four main assumptions.
(i) Rational behavior of the consumer: It is assumed that individuals are rational in making decisions from their expenditures on consumer goods.
(ii) Utility is ordinal: Utility cannot be measured cardinally. It can be, however, expressed ordinally. In other words, the consumer can rank the basket of goods according to the satisfaction or utility of each basket.
(iii) Diminishing marginal rate of substitution: In the indifference curve analysis, the principle of diminishing marginal rate of substitution is assumed.
(iv) Consistency in choice: The consumer, it is assumed, is consistent in his behavior during a period of time. For insistence, if the consumer prefers combinations of A of good to the combinations B of goods, he then remains consistent in his choice. His...