Criticism of Indifference Curve Theory

Transcription

1 Criticism of Indifference Curve Theory In today s lecture we will discuss about criticisms of Indifference curve theory. The objective of this lesson is to find out, or to learn about the defects of Indifference curve theory. We have seen that the Indifference curve theory is superior to the marginal utility theory you can enlist three advantages of using Indifference curve theory 1. It is more realistic because it takes cross effects into account. 2. It is simpler because it makes minimum of assumptions. 3. It is more scientific because it is not based upon the absolute measurability of utility or satisfaction. Despite these admitted merits, Indifference curve analysis suffers from short comings which have led to some criticisms and so, let us look at some of the criticisms leveled against the Indifference curve theory. Now some economist feel that Indifference curves teach us nothing new and therefore they are similar theories and this view is held by some economists particularly by Schumpeter who says the that the new technique has neither proved anything new, nor has it disproved anything old. It is pointed out that the new analysis is only old wine put into a new bottle. Instead of the concept of utility, the new analysis has introduced the term preference. The old concept of marginal utility, has its counterpart in the new concept of marginal rate of substitution, the old law of diminishing utility has been replaced by the principle of diminishing marginal rate of substitution. The old equation of consumer equilibrium has been substituted by the new equation of indifference curve analysis namely the equality of marginal rate of substitution between the commodities with their price ratio it is evident from these diagrams

2 Criticism of Indifference Theory: 1. The Marshallian utility analysis explains that, in order to maximize consumer satisfaction the consumer has to spend in such a manner that the marginal utility of A by price of A equals to the marginal utility of B by the price of B is equal to the marginal utility of C by the price of C and so on which is ultimately equal to marginal utility of money. Whereas under the indifference curve theory marginal rate of substitution of X for Y should be equal to the price of X by the price of Y and so the ratio of the MRS utilities should be equal to the ratio of the prices in the second case and therefore nothing new has been done this is the view of certain economies. 2. The second defect can be explained as follows: the indifference curve analysis is based upon the wrong or unrealistic assumption that a consumer is familiar with his entire preference schedule this is calling for too much. No consumer, before consuming the good, knows how much of satisfaction he can derive from all the combinations that are available. In other words when we have an indifference schedule, there are many indifference curves, and higher indifference curves indicate high level of satisfaction and the consumer knows his indifference schedule. It means that even before consuming the good, the consumer is able to know what are all the combinations that give a particular level of satisfaction and what are the other combinations that give him other levels of satisfaction. This is not possible, it is not realistic and therefore, one is a little bit inconvenienced when he looks at this assumption that consumers are aware of their consumer schedule or the consumer s indifference schedule is given. As you remember, under the indifference curve analysis, it is assumed that we know the prices of the goods, we know the incomes of the consumers and we also are given the indifference schedule of the consumer. So unless we know all these three, we cannot take up indifference curve analysis and the difficulty is that no consumer may be knowing all the preferences that he has and all the combinations that are available how much of satisfaction he is going to derive from these. This is difficult for the consumers to make up. It is possible that a consumer may be knowing a part of his indifference curve he knows about some preferences but it may not be possible for him to know about each and every combination that might be available. For example he may not be able to say that one apple and fifteen

3 bananas will give him the same satisfaction as ten apples and one banana. Although a consumer may have somewhat precise knowledge of one or two combinations of the two goods in the immediate neighborhood of his actual purchase, he is not expected to have an accurate idea of the satisfaction that he would derive from all the combinations that may be available. In other words, a consumer does not have full knowledge of his entire preference schedule or his entire indifference curve. At best he may have knowledge only of a part of his preference schedule or indifference curve. Another unrealistic element of this analysis is that indifference curves include even the most absurd combinations of the two goods which the consumer in question can never think of accepting. For example two shoes and five pairs of socks may be one combination which might be one of his preferences but if you think of another preference that might be available: Three pairs of shoes and two pairs of socks, this seems absurd and ridiculous and therefore the extreme cases also may be absurd on the indifference curve when you have extreme cases they also may be observed and therefore we can see that indifference curve analysis is based on wrong and the unrealistic assumptions that the consumer is familiar with his entire preference schedule and that all the combinations that are on the indifference curve have to be analyzed because the extreme cases and some other combinations may be ridiculous as we have seen. 3. Now the third criticism is that indifference curve analysis assumes that consumers are rational or they behave in a rational manner when they purchase goods, but this may not be true because, when we purchase goods in the market we may be influenced by various factors and we may not be rational in the sense that in the indifference curve theory it is assumed that the consumer will prefer the highest indifference curve compared to the other indifference curves and this means that he is rational but when we look at the practical aspect, we find that many consumers are not really rational when they make their purchases and therefore this can be criticized but some economists feel that if we do not make such an assumption, then we are not able to make an analysis and therefore for simplicity such an assumption is required and we assume that the consumer is rational, he is always attempting to maximize his satisfaction. Here it means that a consumer prefers a larger bundle to a smaller bundle of the combination of goods and therefore the indifference curve analysis is based upon an assumption that economic rationality prevails over a consumer, but

4 even though it is criticized, this assumption may be required in order to have a theory. Otherwise if everyone behaves in a different manner it will be difficult to formulate a theory. 4. The fourth criticism is that the theory assumes that the consumer spends all his money income on two goods. The indifference curve analysis is based on the usual assumption that the consumer spends his money income on two goods. This can be questioned because a consumer may spend his income on more than two goods. But we are only taking two goods. Now here again some people criticize that this may not be realistic. Others justify this by saying that if you take more than two goods, it becomes difficult to understand, it becomes complicated to handle also. In fact this is again another criticism that people. They say that if we have more than two goods then it becomes difficult to handle. Because geometrically we can handle a case where there are only two goods and therefore if you have more than two goods then we have to use the mathematical method and mathematical method will become more complex and analysis may become very difficult and therefore this abstractness would creep in and make analysis more difficult and complicated. But definitely more than two goods also can be accommodated. The only thing is that when more than two goods are accommodated, then it would make the analysis more complicated. 5. The fifth criticism is that indifference curve analysis is only microeconomic in character. In other words under indifference curve analysis only a single consumer is analyzed or the behavior of the single consumer is analyzed and therefore from this we can make out that the indifference curve theory does not lend itself for group equilibrium analysis and for an economy it was always necessary for one to analyze what happens in the market and therefore when you talk about a market it involves all the consumers put together. So may be this criticism can be taken because definitely there is a short coming here that it only analyses the behavior of a single consumer but it does not help us to analyze group equilibrium or group behavior in the market. 6. Now the sixth criticism states that the indifference curve analysis is not very amenable to empirical research therefore we can again clearly state that this criticism is about indifference curve analysis not being amenable to empirical research. So what is this mean? It is very easy to talk about an indifference curve, to talk about preferences, to talk about the scale of preferences and so

5 on. But it is not so simple to get data on these aspects and therefore when we are not able to get data on such aspects we will not able to do empirical research on those aspects and therefore this criticism can also be well taken. 7. Now the seventh criticism is about the continuity of the indifference curves. Another unrealistic assumption of indifference curve analysis is continuity. The indifference curves are continuous curves but what is the implication of continuous indifference curve? The implication is that there are infinite number of points on the indifference curve and these infinite points represent infinite number of combinations that might be available in the market. But the question is, are all these combinations available in the market? And also it calls for divisibility of the goods that are measured on the two axes. A continuous indifference curve implies perfect divisibility of the goods that are measured on the two axes. For example if we are talking about tooth brushes and tooth pastes. So on one axis we are measuring the tooth brushes and other we are measuring tooth paste. We may have a combination which calls for two and half brushes and five and quarter tooth paste tubes. So we see here that we may get tooth paste in tubes but we don t get fractions of those tubes. We cannot ask for a quarter tube and in the same manner we get brushes and we cannot make it two and half brushes of the product comes into effect here. But then that is questionable when goods are not infinitely divisible, when they are not divisible into small quantities then you cannot have a continuous indifference curve but then later on people talked about a kinked indifference curve. The kinked indifference curve would have many combinations that are available but the curve would not be a continuous (smooth) one it would be kinked and later on people came out with kinked indifference curves but once you take kinked indifference curves, then you cannot apply the mathematics that we are applying here. In the analysis of a continuous curve we can use differential calculus but when you have kinked indifference curves you may have to use linear. The tool will have to change and therefore even though this defect is found in indifference curves. In fact ultimately even Hicks who formulated this theory initially, gave up the use of the indifference curves (later on) and therefore there is some difficulty with these curves which are imaginary lines and which may bring to the fore many problems that we may not be able to handle.

6 8. Now the eighth criticism is as follows: This analysis is based upon weak ordering. What is weak ordering? Now when we say weak ordering, it means that all the combinations that lie on a single indifference curve give the same satisfaction or utility to the consumer and therefore they cannot be ranked. All the combinations that are found on a particular indifference curve will have only one rank. Whereas all the combinations that lie on another indifference curve, will have another rank. But among themselves those combinations cannot be ranked and therefore when we give a rank, the same rank to many combinations, then we say that there is weak ordering of preferences. Weak ordering means allotting the same rank to many combinations. So this is one difficulty that we find and therefore there is criticism about this point also. Now let us look at it in this manner: Suppose you have an indifference curve and the consumer chooses the point A on it and there is another point on the same indifference curve B. Now if a consumer clearly knows that he prefers A to B, then this ordering is not called weak ordering it is called strong ordering. But when the consumer prefers both of these, he is indifferent between these two combinations so when the consumer is indifferent between the two combinations A and B because they lie on the same indifference curve, they give him the same level of satisfaction then a consumer may be indifferent between these two and therefore he can t rank and say which is first and which is second and here we come across the case of weak ordering so this is the difference between strong ordering and weak ordering. Under the indifference curve analysis, we only have weak ordering of preferences. 9. This theory is very complicated unlike the comparatively simpler utility analysis the indifference curve analysis is very complicated and complex, necessitating a sufficiently developed level of understanding. The analysis becomes particularly complicated when it is extended to more than two commodities, necessitating the use of three dimension diagrams and commodities and complex algebraic methods. It was primarily on the account of its complexity, that doctor Marshall was forced to reject it in favour of the comparatively simpler utility analysis. Despite these defects and drawbacks the fact remains that indifference curve analysis is accepted as a considerably improved version over the conventional or the Marginal utility analysis and now its finds a respectable place in modern economic theory. Despite these defects we can clearly say that the

7 indifference curve theory is superior to Marshall s utility theory. In other words the new theory is superior to the old theory which Marshall talks about. Summary In this lecture we have tried to find out the criticisms that are leveled against indifference curve theory. We saw that there are number of criticisms but on the whole we have come to a conclusion that definitely indifference curve theory is preferable to the Marshallian utility theory. Questions: 1. Critically examine the indifference curve theory, or it could also be, 2. What are the criticisms leveled against indifference curve theory? References: 1. Micro Economics by M.L. Seth 2. Micro Economic by Kouthsoiyanis