Some economists say happiness can't be measured, but indifference curves come pretty close to doing just that by measuring consumer preference for products. For businesses this can help an owner, investors or managers determine how much their products or services are valued in relation to an alternative. In turn, pricing and marketing decisions can be made using indifference curves to optimize revenue.
Indifference curves are plotted on an indifference graph with an X and Y axis i.e. vertical and horizontal lines. The X axis represents the amount of product A, and the Y axis the same for product B. If Mr. Jones, really likes product A, then the decline in marginal utility by having more of product A than B will be slight and represented by a steeper indifference curve. Additional curves can be added to represent indifference for two products at different price levels.
If Mr. Jones values both product A and product B equally, the indifference curve will take on a more triangular shape in terms of the X and Y axis. The indifference curve is determined by plotting volume of preference for item A if no B items are used, then re-plotting the amount of A, if one unit of B is purchased and so on until all that is left are B items.
Suppose Mr. Jones enjoys red apples more than green apples. Since he likes red apples the prospect of obtaining one green apple in exchange for one red apple is not pleasing. Thus, in order to give up a red apple, Mr. Jones will require 2 green apples. This leads to a steeper slope than a one for one exchange. By listing purchase statistics on a spreadsheet when price changes take place, the information for an indifference curve becomes available.
Indifference curves are useful tools for businesses because they can be used to monitor consumer preferences via purchase patterns. If it becomes evident that red apples are more favored for example, an apple retailer may choose to raise the price of apples and lower the price of green apples as consumers may choose to buy the red apples regardless of a small price increase. This is the elasticity of demand.
To illustrate further, if sales of red apples remain the same with a price increase based n the indifference curve, then the retailer has made a good decision. However, what if he lowers the price of red apples? Would this lead to a purchase of more apples, and if so would that amount to more profit than had the price remained the same or if it had been raised? To determine this the profit for each apple sold at each price level must be multiplied by the number of apples sold.
Indifference curves are plotted on an indifference graph with an X and Y axis i.e. vertical and horizontal lines. The X axis represents the amount of product A, and the Y axis the same for product B. If Mr. Jones, really likes product A, then the decline in marginal utility by having more of product A than B will be slight and represented by a steeper indifference curve. Additional curves can be added to represent indifference for two products at different price levels.
If Mr. Jones values both product A and product B equally, the indifference curve will take on a more triangular shape in terms of the X and Y axis. The indifference curve is determined by plotting volume of preference for item A if no B items are used, then re-plotting the amount of A, if one unit of B is purchased and so on until all that is left are B items.
Suppose Mr. Jones enjoys red apples more than green apples. Since he likes red apples the prospect of obtaining one green apple in exchange for one red apple is not pleasing. Thus, in order to give up a red apple, Mr. Jones will require 2 green apples. This leads to a steeper slope than a one for one exchange. By listing purchase statistics on a spreadsheet when price changes take place, the information for an indifference curve becomes available.
Indifference curves are useful tools for businesses because they can be used to monitor consumer preferences via purchase patterns. If it becomes evident that red apples are more favored for example, an apple retailer may choose to raise the price of apples and lower the price of green apples as consumers may choose to buy the red apples regardless of a small price increase. This is the elasticity of demand.
To illustrate further, if sales of red apples remain the same with a price increase based n the indifference curve, then the retailer has made a good decision. However, what if he lowers the price of red apples? Would this lead to a purchase of more apples, and if so would that amount to more profit than had the price remained the same or if it had been raised? To determine this the profit for each apple sold at each price level must be multiplied by the number of apples sold.
Sources:
1. http://bit.ly/eVWc2E (Cornell University)
2. http://bit.ly/gkr7Rs (Investopedia)
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