An indifference curve is a somewhat technical economic concept that measures the reaction of consumers to a bundle of goods or services. As with many economic concepts, it is represented on a right angle graph, with the quantity of one product listed on the vertical axis and the quantity of a different product listed on the horizontal axis. The curve starts at the top left of the graph and slopes down and to the right. The purpose is to measure how much of one product a consumer will give up in preference for another. Utility plays a key role in the measuring of product values to consumers.
In economic terms, utility is seen as the measure of satisfaction a consumer will receive from a good or service. Consumers may increase or decrease their utility from a product by purchasing more or less, depending on their indifference to the bundle of products. However, consumers may experience the law of diminishing returns, which means that consumers will experience less utility after a certain consumption level of goods and services.
Economic graphs can include several product bundles using an indifference curve for each bundle. This allows individuals to analyze multiple products at one time. An indifference graphic is curved, meaning that consumers will typically have a negative substitution effect since consumers may be dissatisfied with having to purchase one good in place of another. Income also plays a role in substitute goods, since consumers may be unable to purchase certain goods based on the price charged by businesses. This creates a negative slope in for the indifference curve.
Two goods can be perfect substitutes, meaning the indifference curve will have a constant curve because consumers will be more willing to accept substitutes at different intervals on the curve. In this scenario, consumers may purchase a cheaper good because they do not see it as having less utility than the higher priced product. Therefore, the point on the indifference curve will go up or down the curve, depending on consumer preference for different product bundles.
Goods or services may be perfect complements, meaning that consumers purchase certain products in relation to each other. For example, increasing sales of hot dogs will often lead to higher sales of hot dog buns. In this scenario, the indifference curve would be L-shaped. Each product would be affected differently, based on the product price or availability of substitute goods. Additionally, factors that affect the consumption of one item may not affect consumption of the complimentary good.