A Critical Evaluation of the Indifference Curve Analysis
No New Subject Matter
Hicks and Allen, in an attempt to find an alternative approach to Marshall’s utility analysis, have described the indifference curve analysis. However, many economists feel that the indifference curve is not an alternative to cardinal utility theory, but a replica of it.
For instance, according to Prof. D.H. Robertson, the indifference curve analysis is just "the old wine in a new bottle." Robertson further states that the indifference curve analysis has simply substituted new terms in the place of old ones. The following table shows how the concepts of cardinal utility theory have been replaced with new concepts.
Cardinal Utility Theory
Indifference Curve Analysis
1. Diminishing marginal utility
Marginal rate of substitution
3. Cardinal number system (one, two, three,..)
Ordinal number system (first, second, third,...)
4. Equilibrium condition: MU of X/price of X = MU of Y/price of Y (Proportionality Rule)
Equilibrium condition: MRS of X for Y = price of X/price of Y
According to Prof. Schumpeter, from a practical standpoint, we are not much better off when drawing purely imaginary indifference curves than we are when speaking of a purely imaginary utility function.
Furthermore, Prof. Armstrong claims that Marshall’s concept of marginal utility is the base for Hicksian principle of diminishing marginal rate of substitution. He points out that Marshall’s concept of marginal utility is the reason why the MRSxy diminishes and the indifference curve is convex to the origin. If the consumer increases the stock of commodity X, the marginal utility of commodity X in terms of commodity Y will start decreasing and at the same time, marginal utility of commodity Y will start increasing. Hicks has not admitted the fundamental concept of utility in his analysis. However, by means of terminological manipulation, the concept of diminishing marginal utility is there in the indifference curve analysis always. Because of this reason, economists claim that it is the reformulation of Marshall’s utility theory.
Limitations of the Indifference Curve Analysis
Ignorance of market behavior
In indifference curve analysis, we are concerned only with the two commodities under consideration. However, the market has many other commodities. We do not consider them in the analysis. For instance, price change of a commodity in the market may influence the purchase of the commodities under consideration. Hence, indifference curve analysis ignores market behavior.
Indifference curve analysis is a two-commodity model. It means that the analysis considers only two commodities while studying a consumer’s economic behavior. If you try to include more than two commodities in the analysis, the mathematical calculation becomes more tedious. When you use high-level mathematics in an economic analysis, you tend to miss economics in the analysis.
Ignorance of demonstration effect
Duesenberry’s demonstration effect is an eminent concept in studying an individual’s consumption pattern. Duesenberry’s demonstration effect states that an individual’s consumption pattern is influence by the level of consumption of others. The indifference curve analysis ignores Duesenberry’s demonstration effect.
Ignorance of risks and uncertainties
Risks and uncertainties are inevitable in real life. John Von Neumann and Oskar Morgenstern in their book ‘The Theory of Games and Economic Behavior’ attributes that an indifference curve analysis has no ability to analyze a consumer’s behavior while risks and uncertainties prevail. On pointing out the same drawback of indifference curve analysis, Prof. Samuelson has termed the entire technique as non-operational.
The indifference curve method facilitates the analysis of an individual’s equilibrium position. However, if you want to study the equilibrium position of a society that consists of many individuals, indifference curve analysis will be of no use, as aggregation of individual consumption pattern is not explained.
The indifference curve analysis assumes that the human being under consideration is rational in decision-making. However, the analysis requires not merely rationality but highly introspective information from the consumer. Tedious introspection is necessary because the consumer should rank all combinations of commodities according to his preference. For an individual, it is a difficult task. Therefore, Hicks himself has corrected it later in his ‘Revision of Demand Theory.’ Consequently, Prof. Samuelson has come up with a theory known as ‘revealed preference theory’, which is based on a behaviorist model.
An indifference curve is the locus of various combinations of two commodities, which yield same level of satisfaction. Suppose the two commodities under consideration are cars and bikes. These two commodities are indivisible. However, the indifference curve can still give you the combination of 3.5 cars and 2.5 bikes in order to maintain the same utility level, which is absurd.
Continuity of indifference curves
Hicks claims that an indifference curve is smooth and continuous. However, this happens to be a highly unrealistic assumption.
Constancy of tastes and preferences
Furthermore, the whole technique holds well on the assumption that consumer’s tastes and preferences are constant throughout the analysis. This assumption is unrealistic because there are various external factors to influence an individual’s consumption behavior. Therefore, the indifference curve analysis is not conducive to empirical research.
Keeping in view all the criticisms mentioned above, we could conclude that the indifference curve analysis does demonstrate a significant improvement to Marshall’s cardinal utility analysis. However, the analysis is not capable enough analyze the highly unpredictable consumer’s behavior.
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© 2013 Sundaram Ponnusamy