A2 Economics – deriving the demand curve from indifference curves.

Some textbooks for the CAIE A2 Economics course don’t cover indifference curve analysis in detail and tend to just focus more on the income and substitution effect. For essays at A2 level it is important to show an understanding / analysis of how you can derive the demand curve of a product against income or price by using the indifference curves in an indifference map.

An indifference map contains information on the quantity of a product a consumer will purchase at different prices and different incomes. So you should be able to see that deriving the demand curves is simply a matter of transferring the price-quantity and income-quantity relationships onto new graphs. By altering the price of the product and the income of the consumer, you can find the price-consumption curve and the income-consumption curve on the indifference map. The two sets of graphs illustrate the price-consumption curve, income-consumption curve and their corresponding individual demand curves.

To find the price-consumption curve (left graph), we alter the price of the product only, causing the change in the budget line as shown in the graph. The budget lines B1, B2, and B3 on the indifference map correspond to the prices P1, P2, and P3 on the individual demand curve. Note that we are dealing with a normal good here. The individual purchases more good X (say, at B3) because it is cheaper (at a price P3). Of course, this is mainly the substitution effect at play. Only three sets of budget lines and indifference curves are shown here. But you can derive more points by shifting the budget lines and finding their corresponding indifference curve.

For the income-consumption curve (right graph), we alter the income or budget of the individual, shifting the budget curve parallel. At any price, say P, the quantity purchased increases as the income increases due to good X being a normal good. It should be clear that each budget line corresponds to one and only one indifference curve as only one indifference curve can intersect the budget line at the tangent. So when you shift the budget line, parallel or not, you need to find its new corresponding indifference curve. The trick is to find out the slope of the new budget line or the price ratio. Note that the slope of the new budget line equals the slope of the indifference curve at the tangent, and the slope of the indifference curve is the marginal rate of substitution (MRS).

Source: Wells Yuan – Yr 13 student (2023)

For more on Indifference Curves view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.