Question

To derive the demand curve of a product in indifference curve analysis, the

• tastes and preferences of the consumer are assumed to be fixed.

• prices of both products are assumed to be variable.

• money income of the consumer is assumed to be variable.

• budget line is assumed to stay in a fixed position.

Answer 1

Answer: Option –(A) Tastes and preferences of the consumer are assumed to be fixed

Explanation: indifference curve is a curve having several locus of points each representing a combination of two different commodities, which gives equal level of satisfaction to the consumer. Similarly the budget line is a line having several locus of points each representing a combination of two different commodities, that best a consumer can purchase, provided the price of the product and budget of the consumer should remains constant. A rational consumer, in order to maximise satisfaction will operate at that equilibrium level of output where budget line becomes tangent to the indifference curve.

With the help of indifference curve analysis, we can derive the demand curve of a product, the demand curve shows inverse relationship between price and quantity demanded for a product. in other words if the price of a product decreases its quantity demanded increases and vice versa. The demand curve further assumes that the

1. Taste and preference of the consumer should be fixed so option (A) is true

2. No change in the money income of the consumer therefore option (C) can’t be true,

3. Price of related goods should remain constant.

In the above diagram the upper part of the diagram shows that that the consumer attains equilibrium at point E1 where BL1 tangent to IC1, where the consumer consumes Q1 of good X, with the fall in the price of good X (P1 to P2) increases the real income of the consumer, because good X becomes more cheaper compared with good Y( whose price remains unchanged). Because in estimating the demand curve of a product with the help of indifference curve analysis, price of both the product can’t be variable, one must be constant so option (B) can’t be true.

Though good X becomes cheaper compared with good Y, with the given budget due to fall in price the consumer can purchase more of good X due to income effect and substation effect. As a result there is shift of budget line from BL1 to BL2 and the new budget line BL2 tangent to IC2 at new equilibrium point E2, where the consumer consumes Q2 of good X . So in order to estimate demand curve of a product with the help of indifference curve analysis budget line can’t be assumed to stay in a fixed position. So option (D) can’t be true. The below part of the diagram shows the demand curve DD of good X, which shows with a fall in price from P1 to P2 there is increase in quantity demand from Q1 to Q2.