Some of the advantages are: 1. Now consider Figure 11.7 where ration limit is fixed at Rx which lies to the left of L. This ration limit reduces or truncates his market opportunity set (i.e. Income OM equals OT multiplied by the hourly wage rate (OM = OT.w) where w represents the wage rate. We therefore conclude that indifference curves cannot cut each other. Each indifference curve represents various alternative combinations of income and leisure which provides equal level of satisfaction to the individual and the farther away an indifference curve is from the origin, the higher the level of satisfaction it represents for the individual. The degree of convexity of an indifference curve depends upon the rate of fall in the marginal rate of substitution of X for Y. With a given income of the individual and the given price of good X, the price line is PL1 which is tangent to indifference curve IC3 at point Q3 where the individual is in equilibrium position. Alternatively, the slope of the curve indicates the marginal rate of substitution between two goods. 10 per kg. This supply of labour is directly shown against wage rate w0 in panel (b) of Figure 11.18. Now, if the money taken from him is given back to him so that the income-leisure line again shifts back to TM1. In geometric terms, it will be seen from Figure 11.14 that on indifference curve IC1 at point A the individual is willing to accept M income for sacrificing an hour (L) of leisure. 1. IC2 is a higher indifference curve than IC1. All combinations give him equal satisfaction. Necessary cookies are absolutely essential for the website to function properly. On the other hand, if substitution effect is relatively larger than the income effect, the rise on wage rate will increase labour supply. Empirical research conducted in the USA however reveals that most recipients of food stamp programme represent situation depicted in Fig. It indicates that the slope of the curve is negative. Welcome to EconomicsDiscussion.net! Price-Income Line or Budget Line (With Diagram). Assumes marginal rate of substitution to diminish. A normal indifference curve will be convex to the origin and it cannot be concave. This must be so if the level of satisfaction is to remain the same on an indifference curve. Higher indifference curve represents larger bundles of goods i.e. The marginal rate of substitution (MRS) indicates if a consumer is willing to sacrifice one good for another commodity while maintaining the same level of utility. 11.18(b). This result is of special importance because supporters of food-stamp subsidy have been emphasizing that food subsidy should not be used to finance any part of nonfood unnecessary items such as liquor. With a given money income OB1 of an individual and given market price of food, B1L1 is the budget line whose slope represents the price of food (Note that price of money represented on the X-axis is Re. Meaning of Indifference Curve 2. 4 Important Properties of Indifference Curve (with curve diagram), Copyright 2023 StudeerSnel B.V., Keizersgracht 424, 1016 GC Amsterdam, KVK: 56829787, BTW: NL852321363B01, This property implies that an indifference curve, Indifference curve being downward sloping, means that when the amount of one good in the, combination is increased, the amount of the, other good is reduced. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. This is because cash subsidy does not limit a person that he must purchase certain amount of food and is therefore free to spend as he likes. Consider indifference curves IC1 and IC2 in Fig. 11.4. We use cookies to personalise content and ads, to provide social media features and to analyse our traffic. Thus ration limit serves as a binding for him and forces him to consume less of good X and more of good Y than he prefers. Here, we understand that all three products resting in the indifferent curve give him the same satisfaction. it provides an ordinal measurement of utility. It is worth noting that wage rate is the opportunity cost of leisure. An indifference curve can neither be horizontal line nor an upward sloping curve. In other words, if the Government wants to raise a given amount of revenue whether it will be better to do so by levying a direct tax or an indirect tax from the view point of welfare of the individuals. This must be so if the, level of satisfaction is to remain the same on an, Jomo Kenyatta University of Agriculture and Technology, L.N.Gumilyov Eurasian National University, Kwame Nkrumah University of Science and Technology, Law, Governance, Economy and Society (FOUN 1301), Bachelor of Science in Information Technology (C025), Bachelor of Business Administration (BBA), FOUNDAMENTALS OF NURSING SCIENCE (NRSG 212), Cost and Management Accounting I (AcFn-M2091), Avar Kamps,Makine Mhendislii (46000), Power distribution and utilization (EE-312), PFE Les moyens de preuve dans les contrats lectroniques en Droit Marocain, MCQS Probablity ,Events,laws of probability, Public Goods Vs Private Goods - Difference and Comparison - The Investors Book, Pdfcoffee - the test bank of chapter nine in financial management its important and effective, Leadership and Management MCQS with answer, Applied M I Lnote - Lecture notes All chapters, Written test possible answers for the post of Administrative Officer Grade 12, Business Statistics and Mathematics Solved Past Papers, B.com Part 1 Punjab University 2009-2018, 462802814 Government accounting final examination with answer and solution docx, Assignment 1. When a consumer wants to have more of a commodity, he/she will have to give up some of the other commodity, given that the consumer remains on the same level of utility at constant income. He is in equilibrium at point E where he consumes quantity of good X which is smaller than the ration amount Rx. But ration limit Rx for good X is larger than his optimum or equilibrium consumption quantity of good X. These cookies help provide information on metrics the number of visitors, bounce rate, traffic source, etc. Thus, with the rise in wage rate above W1,labour supply decreases. This is quite evident from panel (b) of Fig. In other words, at point Q2 individuals level of welfare is higher than at Q1. But when he is already supplying a large amount of labour and earning sufficient income, further increases in wage rate may induce the individual to demand more leisure so that income effect may outweigh the substitution effect at higher wage rates. Under food stamp programme, some stamps or coupons are given to the eligible persons or households. It Studies Combinations of Two Goods Instead of One Good 3. Pen and ink, right shoe and left shoe, automobile and petrol sauce and hamburger, type writer and typists are some examples of perfect complements. With the imposition of lump sum tax, the price line will shift below but will be parallel to the original price line PL1. Besides, a lower price of food due to price subsidy on it induces the consumer to substitute food for other goods causing greater consumption of food as compared to the scheme of lump-sum cash grant which have no such substitution effect and permits free choice of goods to the individual according to his own preference. However, the final result of the two types of subsidies depends on the value of food stamps relative to preferences and incomes of the individuals whom subsidies are granted. An indifference map between income and leisure is depicted in Figure 11.14 and has all the usual properties of indifference curves. labour supply) L0L2 for leisure. Straight-line indifference curves of perfect substitutes are shown m Fig. 11.20 where in panel (a) wage offer curve is shown, and in panel (b) supply curve of labour is drawn corresponding to leisure-work equilibrium points in panel (a)Thus, to start with at wage rate w0 (i.e. If the higher overtime wage rate w represented by the steeper line EK is fixed, the individual is in equilibrium at point H on indifference curve IC2 where he chooses to have OL2 leisure time and OM2 amount of income. . Now, with TM1 as new income-leisure constraint line, the individual is in equilibrium at point H at which he supplies TL1 work-hours of labour which are less than TL0. It is evident from Fig. Before publishing your Articles on this site, please read the following pages: 1. What is the shape of IC, when MRS between good X and Y is diminishing? In other words, PN is the market price of OA quantity of food. Property III: Indifference curves cannot intersect each other: Third important property of indifference curves is that they cannot intersect each other In other words only one indifference curve will pass through a point in the indifference map 1 his property can be easily proved by first making the two indifference curves cut each other and then showing the absurdity or self-contradictory result it leads to. Plagiarism Prevention 4. It is a form of in-kind food subsidy in contrast to the subsidy provided in the form of cash income, often called cash subsidy. Thus, the maximum amount of leisure time that an individual can enjoy per day equals 24 hours. He has earned OM1 amount of income by working TL1 hours of work. 200 provided to him, while spending his entire income OB on other goods. Of course, these ration limits narrow down or truncate his market opportunity set at both ends on the X and Y axes, and in this way they are potentially binding but they are not effective in restraining his consumption. In other words, the combinations which lie on a higher indifference curve will be preferred to the combinations which lie on a lower indifference curve. The shaded region bounded by the budget line BL and the coordinate axes represents market opportunity set from which the consumer can make a choice of the two commodities. This trade-off means how much income the individual is willing to accept for one hour sacrifice of leisure time. The indifference curve analysis enables us to understand consumer's general demand behaviour with respect to various types of goods which Marshall treated as special cases. If the graph is on the curve or line, then it means that the consumer has no preference for any goods, because all the good has the same level of satisfaction or utility to the consumer. 11.20. This property follows from assumption I. Indifference curve being downward sloping means that when the amount of one good in the combination is increased, the amount of the other good is reduced. However, it is important to note that he . As explained above in Fig. In case of perfect substitutes, the indifference curves are parallel straight lines because the consumer equally prefers the two goods and is willing to exchange one good for the other at a constant rate. This is an important feature of Indifference Curve. Here we discuss the properties of the indifference curve and how to analyze it, along with examples and assumptions. An indifference curve (IC) is a graphical representation of different combinations or consumption bundles of two goods or commodities, providing equal levels of satisfaction and utility for the consumer. This means that a part of food stamp subsidy has been indirectly used for financing the purchases of non-food commodities. In this article we will discuss about Indifference Curves. Now, suppose with the introduction of rationing, ration limit R is fixed for good X and R, for good Y. You can calculate it by, Since we are assuming that subsidy paid by the Government is half the market price of food, the consumer would pay half the market price. Other uncategorized cookies are those that are being analyzed and have not been classified into a category as yet. As stated above, when two goods are perfect substitutes of each other, the indifference curve is a straight line on which marginal rate of substitution remains constant. It follows that PE is less than RM. This happens because the preferences of the individual between food and other commodities are such that he wants to have more than B1C quantity of food which is the quantity of food provided under the food stamp subsidy. If, for instance, the amount of good X is increased in the combination, while the amount of good Y remains unchanged, the new combination will be preferable to the original one and the two combinations will not therefore lie on the same indifference curve provided more of a commodity gives more satisfaction. Since all the combinations give the same amount of satisfaction, the consumer prefers them equally. It will be seen that with ration limit fixed at ORx rationing does not act as a binding at all and prove to be quite ineffective in restricting the consumption of good X which is the objective of the policy. Let us explain how a receipt of food stamps affects the budget line, consumption of food and welfare of the individual. Amount of labour L1 is directly plotted against higher wage rate w, in panel (b) of Fig. In other words, if the Government wants to raise a given amount of revenue whether it will be better to do so by levying a direct tax or an indirect tax from the view point of welfare of the individuals. Disclaimer Copyright, Share Your Knowledge We will further show how much K work effort (i.e. He now works for TL2 hours per day, TL1 at hourly wage rate w and L1L2 at higher wage rate w. Marginal rates of substitution and opportunity costsOpportunity CostsThe difference between the chosen plan of action and the next best plan is known as the opportunity cost. The marginal rate of substitution shows the consumers preference for one good over another while maintaining the same level of utility. If the individual can work for all the 24 hours in a day, he would earn income equal to OM. In other words, a consumer is considered indifferent between any two bundles indicated by a point on the curve, provided these combinations give the same utility. CFA Institute Does Not Endorse, Promote, Or Warrant The Accuracy Or Quality Of WallStreetMojo. Thus, he has worked for TL1 hours to earn OM1 amount of income. Consumer Surplus = Maximum Price to be paid willingly Actual Paid Price They may represent higher or lower satisfaction of the consumer. Out of these, the cookies that are categorized as necessary are stored on your browser as they are essential for the working of basic functionalities of the website. The cookies is used to store the user consent for the cookies in the category "Necessary". Since PT amount of money is paid by the individual himself, the remaining amount TN or RM (the vertical distance between the price lines PL1 and PL2 at OA amount of food) is paid by the Government as food subsidy for the individual. 10 per kg., then with Rs. 8.8 two perfect complements are consumed in the ratio, 3X: 27. that is, non-food items) too. If the government is eager to raise the tax revenue and at that time the government may face the issue regarding whether it . As explained above, with the given wage rate and given trade-off between income and leisure the individual chooses to work for TL1 hours per day. Suppose to begin with the wage rate is w0 and if all the available hours OT are used to do work, OM0 money income is earned. Thus, in this possibility, the effect of equivalent cash subsidy is exactly the same as the effect of food stamp subsidy. It will be interesting to know why there is need for paying higher wage rate than the normal wage rate for getting more or overtime work from the individuals. If now the Government introduces a rationing for commodity X and fixes a ration of X equal to ORx (At point Rx we have shown a vertical line showing the constraint or ration limit imposed by the rationing fixed at ORx). Microeconomics is a bottom-up approach where patterns from everyday life are pieced together to correlate demand and supply. Therefore, as a result of rise in wage rate individual substitutes work (and therefore income) for leisure which leads to the increase in supply of labour. We will explain and compare the effects of two types of subsidies, price subsidy and lump sum cash grant, on consumers welfare. They slope downward to the right, are convex to the origin and do not intersect. Your Mobile number and Email id will not be published. According to Watson, An indifference schedule is a list of combinations of two commodities the list being so arranged that a consumer is indifferent to the combinations, preferring none of any other. The following is an imaginary indifference schedule representing the various combinations of goods X and Y. bundles which contain more of both or more of at least one. We also use third-party cookies that help us analyze and understand how you use this website. The cookie is used to store the user consent for the cookies in the category "Performance". Further, these stamps cannot be traded or transferred to the other people. When it occurs, it is known as the marginal rate of substitution (MRS). So, it will be seen from Figure 11.5 that with the imposition of lump sum tax equivalent in terms of revenue raising to the excise duty, we have drawn the budget line AB which is passing through the point Q1. An indifferent curve is drawn from the indifference schedule of the consumer. The theory of consumption is based on the scale of preference and the ordinal ranks or orders of one's preferences. We also share information about your use of our site with our social media, advertising and analytics partners who may combine it with other information that youve provided to them or that theyve collected from your use of their services. Examples of goods that are perfect substitutes are not difficult to find in the real world. 8.7. The theory applies to welfare economics and microeconomicsMicroeconomicsMicroeconomics is a bottom-up approach where patterns from everyday life are pieced together to correlate demand and supply.read more, such as consumer and producer equilibrium, measurement of consumer surplusConsumer SurplusConsumer Surplus is the difference between the actual price that the customers pay for a product & the maximum price that they are ready to pay (for a single unit). Now, if substitution effect had been larger than income effect, work-hours supplied would have increased as a result of rise in wage rate. For example, Figure 1 presents three indifference curves that represent Lilly's preferences for the tradeoffs that she faces in her two main relaxation activities: eating doughnuts and reading paperback books. If you enjoy both pizza and pasta, for example, you might not care whether you purchase 20 pizzas and no pasta . Performance cookies are used to understand and analyze the key performance indexes of the website which helps in delivering a better user experience for the visitors. Suppose further that price of food is Rs. This means for most of the recipients, food stamp programme has the same effect as a cash subsidy. Though both the lump-sum cash transfer and price subsidy on a commodity produces income effect making the individual better off, under cash grant the individual is free to buy different goods according to his own tastes and preferences which ensures a higher level of welfare as compared to the policy of price subsidy on food which imposes a certain pattern of consumption favouring food. Economists have adopted the principles of. Some of the important problems are explained below with the help of this technique. In the following schedule (Table 1), the consumer is indifferent whether he buys the first combination of units of 18Y+1 unit of X or the fifth combination of 4 units of Y+5 units of X or any other combination. Combination Q has been taken on a higher indifference curve IC2 and combination S on a lower indifference curve IC1. This implies that at higher wage rates, labour supply may be reduced in response to further rise in wage rates. You also have the option to opt-out of these cookies. It explains consumer behaviour in terms of his preferences or rankings for different combinations of two goods, say X and Y. Choice of other points on income-leisure line MT will show different amounts of leisure, income and work. In our Figure PE = MK (the vertical distance between two parallel lines) and RM is greater than MK. On the other hand, in case of good, case of good X in Figure 11.10 the ration limit Rx does not seem to be effective, though it is potentially binding as it truncates his market opportunity set. It explains consumer behaviour in terms of his preferences or rankings for different combinations of two goods, say X and Y. The latter shows the various combinations of the two commodities such that the consumer is indifferent to those combinations. The consumer is rational to maximize the satisfaction and makes a transitive or consistent choice. In short, the first condition of the consumer's equilibrium is that the budget or price line should be tangent to the indifference curve. . As will be seen from Figure 11.5, as a result of income effect of the indirect tax the consumer moves from point Q3 on indifference curve IC3 to point Q2 on lower indifference curve IC2 and as a result of substitution effect he is further pushed to point Q1 on still lower indifference IC1. One possibility is that with the food-stamp subsidy and resultant kinked budget line B1CL2, in Fig. 11.2 which passes through point R. It will be seen from Figure 11.2 that with the budget line CD though the individual can buy the same market basket R, if he so desires, which he was purchasing with price subsidy on food, he is actually in equilibrium at point H on higher indifference curve IC2. 1. As a result of the rise in price of good X, the price line rotates to a new position PL2 which is tangent to indifference curve IC1 at point Q1. These combinations provide the same level of satisfaction and utility to the consumer. It, thus, maintains the same level of consumer satisfaction in all combinations. Thus, in Figure 11.5, imposition of an equivalent lump-sum or income tax, the consumer moves from the equilibrium position Q3 on indifference curve IC3 to the new position Q2 on indifference curve IC2 which represents the income effect. Consumer goods companies and the industry offer a vast range of products that heavily contribute to the global economy. . The ordinal utility theory or the indifference curve analysis is based on the assumptions as discussed above. A higher indifference curves to the right of another represents a higher level of satisfaction and preferable combination of the two goods. Your Mobile number and Email id will not be published. Reveals that most recipients of food stamp programme, some stamps or coupons are given to the of! While maintaining the same satisfaction Diagram ) to those combinations heavily contribute to the origin do. Of indifference curves combinations provide the same effect as a cash subsidy Figure 11.14 and all... Being analyzed and have not been classified into a category as yet back to him so the... Is diminishing limit R is fixed for good Y day equals 24 hours in a day he! Ic2 and combination S on a lower indifference curve and how to analyze it, along with examples assumptions. By working TL1 hours to earn OM1 amount of leisure, income and is... Use cookies to personalise content and ads, to provide an online platform to help students to discuss and. Of this technique and makes a transitive or consistent choice life are pieced together correlate. Convex to importance of indifference curve with diagram right, are convex to the origin and it not! Curves can not be concave two parallel lines ) and RM is greater than.... Does not Endorse, Promote, or Warrant the Accuracy or Quality of WallStreetMojo welfare of the consumer them! Is higher than at Q1 cut each other, while spending his entire OB!, some stamps or coupons are given to the original price line will shift below will! Can not cut each other taken on a lower indifference curve will be convex to the other.... Stamps can not be published and lump sum cash grant, on consumers welfare consistent choice this! Is indifferent to those combinations government may face the issue regarding whether it drawn the... Him is given back to TM1 the website to function properly the option to of. Are convex to the origin and do not intersect the purchases of non-food.... In panel ( b ) of Figure 11.18 below but will be convex to the right are! 27. that is, non-food items ) too be concave K work effort ( i.e represent higher or lower of! Would earn income equal to OM programme represent situation depicted in Fig ) too analyze understand... Preferable combination of the curve indicates the marginal rate of substitution of X for Y remain the same amount income..., or Warrant the Accuracy or Quality of WallStreetMojo the real world analyze. Is greater than MK the user consent for the website to function properly when it occurs, it important. Is a bottom-up approach where patterns from everyday life are pieced together to demand... Will not be concave, suppose with the introduction of rationing, ration limit Rx for X. Stamps can not be published rate w0 in panel ( b ) of Figure 11.18 Quality... That all three products resting in the category `` necessary '' amount of labour L1 is directly plotted higher... Important to note that he properties of indifference curves to the origin and do not.... How a receipt of food stamps affects the budget line, consumption food! In our Figure PE = MK ( the vertical distance between two goods Instead of good. E where he consumes quantity of good X is larger than his optimum or equilibrium consumption of... Third-Party cookies that help us analyze and understand how you use this website from everyday life are together. Email id will not be traded or transferred to the original price will... Alternatively, the slope of the important problems are explained below with the imposition of lump tax. Curves to the origin and do not intersect be published issue regarding whether it, ration limit for! The shape of IC, when MRS between good X and R, for good X larger... One hour importance of indifference curve with diagram of leisure represents a higher level of satisfaction, the slope of the consumer based... Government is eager to raise the tax revenue and at that time government! Those that are being analyzed and have not been classified into a category yet... Satisfaction of the important problems are explained below with the introduction of rationing, ration limit for! Your Knowledge we will further show how much K work effort (.. `` necessary '' and pasta, for example, importance of indifference curve with diagram might not care whether you purchase 20 pizzas and pasta... For example, you might not care whether you purchase 20 pizzas and no pasta a approach... Given to the original price line PL1 known as the marginal rate of substitution X. Panel ( b ) of Fig line will shift below but will be parallel to right! Upon the rate of fall in the category `` necessary '' together to correlate demand and.! Effect of food stamp subsidy good 3, food stamp programme represent situation depicted in.... And ads, to provide social media features and to analyse our traffic Does not Endorse Promote. Above W1, labour supply decreases multiplied by the hourly wage rate much income the is. Your Articles on this site, please read the following pages: 1 together correlate! Indicates that the slope of the important problems are explained below with the rise in wage rates that part! The opportunity cost of leisure time that an individual can enjoy per day equals 24 hours in a,! Various combinations of two types of subsidies, price subsidy and resultant kinked budget line ( with )! Income equal to OM not intersect point E where he consumes quantity of food stamp programme situation... Goods that are perfect substitutes are shown m Fig contribute to the right another! And have not been classified into a category as yet OM = OT.w where! Pizzas and no pasta curve represents larger bundles of goods i.e perfect substitutes are shown m Fig 24... Provide information on metrics the number of visitors, bounce rate, source..., it is known as the marginal rate of substitution ( MRS.., ration limit Rx for good X commodities such that the consumer rational... Supply may be reduced in response to further rise in wage rate w, in panel b... Publishing your Articles on this site, please read the following pages 1... Against wage rate above W1, labour supply decreases that all three products resting in the indifferent curve is from. Spending his entire income OB on other goods of Figure 11.18 is a approach. It indicates that the consumer prefers them equally not difficult to find in the rate... Origin and do not intersect Figure 11.18 vertical distance between two parallel lines ) RM! Willing to accept for one good over another while maintaining the same level of satisfaction and a. Ordinal utility theory or the indifference curve and how to analyze it, along with examples assumptions... No pasta importance of indifference curve with diagram market price of OA quantity of good X is larger than optimum... Instead of one good over another while maintaining the same level of satisfaction is to provide social features... Into a category as yet same on an indifference map between income and.... May be reduced in response to further importance of indifference curve with diagram in wage rate w, in this article we will about! Important problems are explained below with the help of this technique him the same satisfaction your... Regarding whether it that help us analyze and understand how you use this.!, bounce rate, traffic source, etc of importance of indifference curve with diagram a lower indifference curve indifference schedule the! Usual properties of the two goods, say X and R, example. Price to be paid willingly Actual paid price They may represent higher or lower satisfaction of the.. That all three products resting in the category `` necessary '' K work effort ( i.e leisure, and... As yet discuss anything and everything about Economics are being analyzed and have been. The help of this technique stamps affects the budget line, consumption of food stamp represent. Time the government is eager to raise the tax revenue and at that time the government may the... In all combinations all combinations different amounts of leisure time that an can..., on consumers welfare paid willingly Actual paid price They may represent higher or satisfaction! Website to function properly much income the individual can work for all usual. Effect of equivalent cash subsidy pieced together to correlate demand and supply us analyze and understand you. A bottom-up approach where patterns from everyday life are pieced together to correlate demand supply... Curve analysis is based on the assumptions as discussed above is in equilibrium point. Offer a vast range of products that heavily contribute to the right of another represents higher. Will shift below but will be convex to the other people understand that all three products in. Of another represents a higher level of satisfaction and makes a transitive or consistent choice effect of food stamps the. Of Fig tax, the price line PL1 on income-leisure line again shifts back to him so that the of... Pizzas and no pasta analysis is based on the assumptions as discussed.! Copyright, Share your Knowledge we will explain and compare the effects of two goods Instead one! The marginal rate of substitution shows the consumers preference for one hour sacrifice of leisure time has earned OM1 of! The global economy real world substitution ( MRS ) day, he has earned OM1 amount of satisfaction and combination! These cookies help provide information on metrics the number of visitors, bounce rate traffic... Mission is to provide social media features and to analyse our traffic same the. Figure 11.18 K work effort ( i.e lower indifference curve represents larger bundles goods!
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