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Unit-4: Ordinal Utility Theory: Indifference Curve Approach

A, B, C, D and E of apples and oranges on AB price line. He cannot buy any combination on Notes
IC because it is far from AB price line. He can only buy those products, which are on line AB
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but also on above most line of indifference curve. Here this curve is IC . The consumer would
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be in equilibrium on combination D (4 oranges + 2 apples) from combination A, B, C, D and E
because on this point, the budget line (AB) is the tangent line of above most indifference curve
IC . There is no doubt that consumer can buy the combination of C or E. But this will not give
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him maximum satisfaction because it is in lowermost indifference curve IC . This means that
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the point of tangency of budget line and indifference curve is consumer’s equilibrium point.
In the words of Watson, “When consumer is in equilibrium, his highest attainable indifference
curve is tangent to budget line.” The slope of indifference curve and budget line is equal on
equilibrium point D. The slope of indifference curve X is marginal substitution rate (MRSxy)
for product Y and the slope of price line is the average of P of product X and P of product Y.
x y
In equilibrium state –

P
Slope of indifference curve = Slope of budget or Price Line or MRS = x
xy P
. y
In summary, the first term of consumer equilibrium is price line should be tangent to indifference curve
means the marginal moving rate for the product X to product Y and the price average of product X and
Y should be equal.
(b) Indifference curve must be convex to the origin: The second term for equilibrium is indifference
curve should be upward to its original point. It means that marginal moving rate for the product X
to product Y should be downward. If indifference curve is Concave and not Convex on equilibrium
point then this is not equilibrium state. This statement is defined by Hicks by Fig. 4.22.

Fig. 4.22

Y

IC
A 2 Point of Tangency

Oranges IC 1 E

R
O X
B
Apples

AB is the price line in Fig. 4.22. IC is indifference curve. Price line AB is tangent line for indifference
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curve IC to point E. So the average of cost of products and marginal moving rate are equal on point E
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but point E is not a fixed stable point. The marginal moving rate is increasing on this point rather than
decreasing. The indifference curve is concave to the root point O on point E, so it does not follow the
second rule of equilibrium. It does not mean that to move left or right from the point E, consumer will
go to the uppermost indifference curve. So the equilibrium will not constant on point E. Tangent line E

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