Basic Assumptions of an Indifference Curve Analysis

• The first assumption of an indifference curve analysis is that utility is ordinal. It means that the utility gained from the consumption of a good cannot be measured in cardinal numbers like 1, 2, 3, etc. It is, therefore, measured in ordinal numbers like 1st, 2nd, 3rd, etc. With cardinal numbers, one can easily compare the different levels of satisfaction by ranking the preferences. 
• The consumer consuming the two goods is assumed to be rational. In other words, the basic motive of the consumer is to maximize his/her satisfaction level through the consumption of two goods. 
• There are only two goods purchased and consumed by a consumer. It is because a graph has only two axes, and the representation of two goods will be easy. 
• The consumer is fully aware and has complete knowledge about the price of both goods in the market. 
• The price of both the goods is already given.
• The taste, income and habits of a consumer remain the same all the time. 
• The preferences of a consumer are transitive. It means that if a consumer prefers Good X over Good Y and Good Y over Good Z, then he/she prefers Good X over Good Z. 

Example:

Nisha is consuming two goods Chocolate and Ice-Cream, and is willing to consume different combinations of these goods to gain an equal level of satisfaction with each combination. These combinations are given in the below indifference schedule. Prepare an indifference curve for the same. 

Solution:

In the above graph, points or combinations A, B, C, D, and E provide the same satisfaction level to Nisha. It can also be seen that as Nisha is consuming one additional quantity of chocolate, she has to sacrifice or give up some quantity of ice cream. Therefore, when Nisha moves from Combination A to B to consume one extra chocolate, she has to sacrifice 8 units of ice-creams. Similarly, to move from Combinations B to C, C to D, and D to E, she has to sacrifice 4, 2, and 1 unit of ice-creams, respectively, for the consumption of one extra unit of chocolate at each movement. This sacrifice of units of a good to gain an additional unit of another good is known as the . 

Marginal Rate of Substitution can be defined as the amount of Good Y sacrificed to obtain an additional unit of Good X without affecting the total satisfaction level.