Question

In: Economics

Indifference Curves Analysis in Economics.

"Under Indifference Curves Analysis, price ratio and MRS are equal to each other at the equilibrium point." Explain it.

Solutions

Expert Solution

Indifference Table -

To explain indifference curves analysis we make the following table where a consumer's indifference position is shown.

 

                                                  Table -1

                                            (Indifference Table)

 

   Combination   Quantity of x    Quantity of y           MRS
           A              1          20              -
           B              2          15              5
           C             3          11              4
           D             4           8              3
           E             5           6              2

 

 

            In the above table we show five combinations of two. commodities x and y, which we call as A,B,C,D and E. At combination A we have 1 unit of x and 20 units of y commodity. At combination B, we have 2 units of x and 15 units of y: at C we have 3 units of x and 11 units of y and so on. All these combinations have been drawn in such a manner that satisfaction derived from all these combinations is equal and the consumer is in different between these combinations.

          Being indifferent means that he values them equally. If we analyse it further we find that the quantity of x is increasing while that of y is decreasing. In other words, x is substituting y. But the rate at which x is substituting y is not constant. Between A to B, 1 unit of x is substituting 5 units of y i.e. the consumer is willing to sacrifice 5 units of y for getting 1 unit of x so that his satisfaction remains the same. In other words, the satisfaction derived from 1 unit of x is equal to satisfaction derived from 5 units of y. Between B to C the consumer is substituting 1 unit of x for only 4 units of y i.e. the rate of substitution falls to 4. Between C to D, this rate falls to 3 and between D to E it comes down to 2. In this way, we can say that as the quantity of x is increasing its Marginal Rate of Substitution (MRS) for y is diminishing.

 

Definition of MRS:

 

"The Marginal Rate of Substitution of x for y is the number of units of y commodity which the consumer is willing to give up for getting an additional unit of x".

 

Symbolically,

 

               MRSxy  =  Delta y / Delta x  = Slope of Indifference Curve

 

Here,

MRSxy  =  Marginal Rate of Substitution of x for y.

Delta x =  change in quantity of x

Delta y = change in quantity of y

 

          To find out the slope of the indifference curve at a given point we draw a tangent at that point and the slope of this line is the slope of the curve and this is the MRSxy at that point.


To explain indifference curves analysis we make the following table where a consumer's indifference position is shown.

 

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