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Indifference curve is a curve that shows different combinations of two goods that yields exactly the same level of satisfaction to a given consumer. In other words, indifference curve is a line that shows all combinations of two goods between which the consumer is indifferent. The indifference cut me slopes down in accordance with the law of diminishing marginal utilities. Indifference curves of an individual do not intercept each other and higher the indifference curve, higher is the utility level.
When a consumer has a fixed income, he spends all of his income and is confronted with market prices of two commodities; he has to move along with a straight line known as budget line. slope of the budget line depends on the ratio of the prices of the two commodities. Whenever there is a change in his income the budget line shifts to right or left.
In order to get maximum satisfaction, a consumer moves along his budget line until he reaches the highest attainable indifference curve. The budget line, at this point, touches the indifference curve but does not intercept the indifference curve. Thus, at equilibrium, the budget line is tangent to the indifference curve.
Price effect is equal to the sum of income effect and substitution effect. The substitution effect measures the effect of change in relative price of any commodity, the real income remaining the same. The income effect measures the change in the quantity demanded of a good for a change in the real income resulting from a change in the price of the good.