Indifference Analysis:  

The aim of indifference curve analysis is to analyze how a rational consumer chooses between two goods. Indifference analysis combines two concepts - indifference curves and budget lines (constraints). An indifference curve is a line that shows all the possible combinations of two goods between which a person is indifferent. In other words, it is a line that shows the consumption of different combinations of two goods that will give the same utility (satisfaction) to the person. An important point is to remember that the use of an indifference curve does not try to put a physical measure onto how much utility a person receives.

The shape of the indifference curve is not a straight line; rather it is convex to the origin. This is due to the concept of the diminishing marginal rate of substitution between the two goods.

The marginal rate of substitution is the amount of one good (i.e. work) that has to be given up if the consumer is to obtain one extra unit of the other good (leisure).

Marginal rate of substitution (MRS) = change in good X / change in good Y

The reason why the marginal rate of substitution diminishes is due to the principle of diminishing marginal utility. Where this principle states that the more units of a good are consumed, then additional units will provide less additional satisfaction than the previous units. Therefore, as a person consumes more of one good (i.e. work) then they will receive diminishing utility for that extra unit (satisfaction), hence, they will be willing to give up less of their leisure to obtain one more unit of work.

The relationship between marginal utility of two goods X and Y and the marginal rate of substitution is often summarized with the following equation;

                                                          MRS = MUx / MUy

It is possible to draw more than one indifference curve on the same diagram. If this occurs then it is termed an indifference curve map.