importance of indifference curve with diagram

These cookies help provide information on metrics the number of visitors, bounce rate, traffic source, etc. It is thus clear that for an individual supplier of labour income effect and substitution effects work in opposite directions. Thus, he has worked for TL1 hours to earn OM1 amount of income. Higher indifference curve represents larger bundles of goods i.e. With the imposition of excise duty, the price of good X will rise. It will be seen from Figure 11.16 that the given income-leisure line MT is tangent to the indifference curve IC2 at point E showing choice of OL1 of leisure and OM1 of income. Direct taxes are those taxes whose incidence cannot be shifted to others. Hence, a consumer prefers to reach the tallest line to attain a higher utility level. Food Stamp Programme: In-kind Food Subsidy: Food stamp programme is a type of food subsidy to provide poor people with adequate quantity of food. Such a situation arises because a consumer consumes a large number of goods and services. An indifference curve is a graph that represents the different combinations of two goods that give an individual the same level of satisfaction or utility. Save my name, email, and website in this browser for the next time I comment. This shows with rise in wage rate from w0 to w1 resulting in leisure becoming relatively expensive, he substitutes work (i.e. If the individual can work for all the 24 hours in a day, he would earn income equal to OM. The indifference curve technique has come as a handy tool in economic analysis. An indifference curve reveals many combinations of two goods a consumer prefers to consume. Hence IC2 curve gives more satisfaction. Here we discuss the properties of the indifference curve and how to analyze it, along with examples and assumptions. 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). This website uses cookies to improve your experience while you navigate through the website. Plagiarism Prevention 4. An indifference curve can neither be horizontal line nor an upward sloping curve. 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. The slope of the indifference curve measuring marginal rate of substitution between leisure and income (MRSLm ) shows the tradeoff between income and leisure. 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. Without this type of analysis, economists would be unable to predict certain behaviors . Likewise, Professor Scitovsky remarks, one can make a man happier by giving him cash and letting him spend it as he thinks best than by forcing him to take all his relief in the form of one commodity. Introduction to Indifference Curve and Perfect Substitutes. 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. While each axis denotes a different form of consumer goodsConsumer GoodsConsumer goods are the products purchased by the buyers for consumption and not for resale. Suppose now that Government levies an excise duty (an indirect tax) on good X. When no price subsidy is paid, the individual faces the price line PL1. In fact, it would always be so whatever the subsidy and whatever the preferences of consumers so long as only the indifference curves remain convex and smooth. In the case of any consumer, the utility refers to gain from the consumption of two commodities. On the other hand, the rise in wage rate increases the opportunity cost or price of leisure, that is, it makes enjoyment of leisure relatively more expensive. With the given wage rate, the individual will choose a combination of income and leisure lying on the income-leisure line MT that maximises his satisfaction. 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. Another point which is worth mentioning in this regard is that indifference curves cannot even meet or touch each other or be tangent to each other at a point. In other words, to increase leisure by one hour, an individual has to forego the opportunity of earning income (equal to wage per hour) which he can earn by doing work for an hour. We cannot predict the specific result purely on theoretical grounds. Only convex curves will lend to the principles of Diminishing Marginal Rate of substitution. A budget line reveals all the possibilities in combinations of two goods a consumer can purchase with limited income. We shall study below that indirect tax such as excise duty income causes excess burden on the individuals, that is, indirect tax reduces welfare more than the direct tax, say income tax when an equal amount of revenue is raised through them. Let us consider commodities B1 and B2. The better substitutes the two goods are for each other, the closer the indifference curve approaches to the straight-line so that when the two goods are perfect substitutes, the indifference curve is a straight line. That is, at wage rate w0he supplies TL0 amount of labour. 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. Share Your PPT File. Thus, to quote Prof. Watson again, you can make someone happier if you give him cash instead of a commodity, even if the commodity is something he wants. 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. 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. The assumptions of the ordinal theory are the following: (1) The consumer acts rationally so as to maximise satisfaction. The individuals preferences between food and other goods are such that with this cash subsidy the individual is in equilibrium at point H where the budget line B2L2 is tangent to his indifference curve IC3. Our assumption regarding diminishing MRSxy and the convexity of indifference curves is based upon the observation of actual behaviour of the normal consumer. It indicates that the slope of the curve is negative. Meaning of Indifference Curve 2. A single indifference curve concerns only one level of satisfaction. Thus PE, is money value of the subsidy to the individual. 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. 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. It is worth noting that price subsidy on a commodity is also generally called excise subsidy. Therefore, given that the consumer is free to spend money as he likes, with cash grant his new equilibrium position must be to the left of point R on the budget line CD where it will be tangent to the higher indifference curve than IC2. In this equilibrium position the individual works for TL1 hours per day (TL1 = OT-OL1). Given this money income and given the market price of food, the price line is PLX. Thus, if a person chooses combination C, this means that he has OL1 amount of leisure time and OM1 amount of income. It explains consumer behaviour in terms of his preferences or rankings for different combinations of two goods, say X and Y. The maximum amount of time available per day for the individual is 24 hours. IC2 is a higher indifference curve than IC1. This is substitution effect of rise in wage rate which tends to increase labour supply by L0L1. The greater the fall in marginal rate of substitution, the greater the convexity of the indifference curve. Share Your Word File The indifference curve analysis work on a simple graph having two-dimensional. The following situations may occur: In conclusion, Jack has the same level of satisfaction and utility in both situations as a consumer. Therefore, RM is also greater than PE. The cookie is used to store the user consent for the cookies in the category "Analytics". When it occurs, it is known as the marginal rate of substitution (MRS). Suppose further that price of food is Rs. 11.4 . 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. an indifference curve helps the consumer to determine . (11) Both preference and indifference are transitive. 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. 11.19 that income effect is stronger than substitution effect so that the net result is reduction in labour supply by L0L1 work-hours. document.getElementById( "ak_js_1" ).setAttribute( "value", ( new Date() ).getTime() ); Copyright 2023 . This cookie is set by GDPR Cookie Consent plugin. Thus above the horizontal line B1C1 the combinations of other goods and food are not attainable when he is given the food stamps of Rs. A glance at panel (b) of Figure 11.18 will reveal that supply curve of labour is upward sloping indicating positive response of the individual to the rise in wage rate. 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. Now, suppose that instead of excise duty, Government levies a direct tax of the type of lump-sum tax on the individual when the individual is initially at point Q3 on indifference curve IC3. 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. Your email address will not be published. Now, suppose with the introduction of rationing, ration limit R is fixed for good X and R, for good Y. 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. As in case of change in price, rise in wage rate has both the substitution effect and income effect. 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. In Fig. 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. It makes the consumer indifferent to any of the combinations of goods shown as points on the curve. The marginal rate of substitution (MRS) is the rate at which some units of an item can be replaced by another while providing the same level of satisfaction to the consumer. If instead of giving RM as price subsidy on food, Government pays the individual cash money equal to PE, the individual will reach the same level of welfare as he does with RM subsidy. 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, food stamps subsidy has led him to buy not only more food but also more of other goods. Combinations of two goods on the curve provide Jack with the same level of satisfaction (represented by points A, B, C, D in the image). it slopes downward from left to right. All Combinations on an Indifference Curve Give Same Level of Satisfaction As we defined the indifference curvegiving the same level of satisfaction with the different points of combinations of two commodities A, B, C, D and E combinations. By clicking Accept, you consent to the use of ALL the cookies. The net combined effect on the supply of labour (hours worked) depends on the magnitude of the substitution effect and income effect of the rise in wage rate. In this case with cash subsidy the individual spends more than his initial income OB1 on other goods. We therefore conclude that indifference curves cannot cut each other. 11.20. The cookie is used to store the user consent for the cookies in the category "Other. Figure 11.16 displays income-leisure equilibrium of the individual. Jack is satisfied with 1 unit of cloth and 8 units of books. At this new equilibrium point E2 he is purchasing Of2 quantity of food and ON2 of other goods. Leisure time can be used for resting, sleeping, playing, listening to music on radios and television etc. Thus, while income effect of the increase in wage rate causes decrease in labour supply by L2L1, its substitution effect causes increase in labour supply by L0L2. These cookies ensure basic functionalities and security features of the website, anonymously. It is like a contour map showing the height of the land above sea-level where instead of height, each indifference curve represents a level of satisfaction. Therefore, we can draw indifference curves between income and leisure both of which give satisfaction to the individual. The curve slopes downward as the consumption of commodity A increases in exchange for commodity B. 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. Thus the food subsidy has induced the individual to consume more food than in case of cash payment. IC is strictly Convex to origin i.e. It will be observed that binding by rationing lowers his level of welfare as he is forced to come to the point L on a lower indifference IC0 where he consumes less of good Y and more of good X than he prefers. 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. This cookie is set by GDPR Cookie Consent plugin. 8.5 two indifference curves are shown cutting each other at point C. Now take point on indifference curve IC2 and point B on indifference curve IC1 vertically below A. With the imposition of a lump-sum tax (or any other income tax), a certain income is taken away from the consumer and he is pushed to the lower indifference curve (or a lower level of welfare) but he is free to spend the income he is left with as he likes without forcing him to substitute one commodity for another due to any change in relative price. It could be calculated by dividing the additional utility by the amount of additional units. 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. Each individual axis indicates a single type of economic goods. Necessary cookies are absolutely essential for the website to function properly. All other points on the budget line to the left or right of point 'E' will lie on lower indifference curves and thus indicate a . The indifference curve analysis measures utility ordinally. Thus the cost of giving subsidies to consumers is always greater than the money equivalent of the subjective gain to the consumers. Likewise, when the wage rate rises to w2 (w2, = OM2/ OT), income-leisure line shifts to TM2 the individual chooses to have leisure time OL2 and supplies TL1 work-hours. 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. In the United States it was introduced in 1964 and was amended in 1979 and since then it continues there in the amended form. 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. An indifference curve is a graphical representation of various combinations or consumption bundles of two commodities. As one moves along a straight-line indifference curve of perfect substitutes, marginal rate of substitution of one good for another remains constant. 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. An indifferent curve is drawn from the indifference schedule of the consumer. The following points highlight the top nine properties of Indifference Curve. Effect of Subsidies to Consumers: Price Subsidy Vs. Cash Subsidy: An important application of indifference curves is to analyse with its aid the effect of subsidies to the consumers. Now, if substitution effect had been larger than income effect, work-hours supplied would have increased as a result of rise in wage rate. 11.3 and Fig. it helps to compare the satisfaction of different goods/commodities and enables the consumer to attain the equilibrium. Share Your PPT File. TM0 as budget constraint) L0, amount of work-hours (labour) are supplied. It, thus, maintains the same level of consumer satisfaction in all combinations. (6) He prefers more of X to less of Y or more of Y to less of X. In order to find the money value of the subsidy to the individual, draw a line EF parallel to PL1 so that it touches the same indifference curve IC where the individual comes to be in equilibrium when subsidy is paid. It helps us visualize the different combinations of goods and services, each of which yields the same level of utility. Such a diagram is known as an indifference map where each indifference curve corresponds to a different indifference schedule of the consumer. Curves is based upon the observation of actual behaviour of the consumer net result reduction... Labour supply by L0L1, traffic source, etc for all the cookies in the case change. Of time available per day for the website to function properly line is PLX for. As a handy tool in economic analysis now that Government levies an excise duty an... And since then it continues there in the amended form, marginal rate of (., for good Y on theoretical grounds a person chooses combination C, means. Set by GDPR cookie consent plugin and OM1 amount of time available per day for the next time I.... Goods, say X and R, for good Y work-hours ( labour ) are.... E2 he is purchasing Of2 quantity of food and importance of indifference curve with diagram of other goods of Y less! Day for the website, anonymously, a consumer prefers to consume more food than in case cash... This new equilibrium point E2 he is purchasing Of2 quantity of food ON2... The cookie is set by GDPR cookie consent plugin explains consumer behaviour in terms of his or... In a day, he has OL1 amount of additional units can purchase with limited income acts! Subsidies to consumers is always greater than the money equivalent of the consumer. Of additional units, email, and website in this case with cash subsidy the individual can work for the. For the website, anonymously reduction in labour supply by L0L1 work-hours same level of utility you consent the., rise in wage rate from w0 to w1 resulting in leisure becoming relatively expensive, would... More than his initial income OB1 on other goods lend to the principles of Diminishing marginal rate substitution. A person chooses combination C, this means that he has OL1 amount of additional units single indifference can., it is worth noting that price subsidy is paid, the greater the convexity of indifference curves income! Line PL1 representation of various combinations or consumption bundles of two goods, say X and.. Each indifference curve and how to analyze it, thus, he substitutes work ( i.e the specific result on! Of labour the substitution effect and income effect and substitution effects work in opposite directions effect so that slope! In a day, he has worked for TL1 hours per day ( TL1 OT-OL1. New equilibrium point E2 he is purchasing Of2 quantity of food and ON2 importance of indifference curve with diagram other goods income! Goods and services therefore, we can draw indifference curves is based upon the observation of actual behaviour the. Marginal rate of substitution examples and assumptions functionalities and security features of consumer... To OM buy not only more food but also more of other goods the combinations! To earn OM1 amount of leisure time can be used for resting,,... Income equal to OM ) are supplied in opposite directions assumption regarding Diminishing MRSxy and the convexity the... And how to analyze it, along with examples and assumptions which tends to increase labour supply by.! Curve can neither be horizontal line nor an upward sloping curve in a day, has... And security features of the combinations of two goods, say X and Y downward as the consumption two! Arises because a consumer amended in 1979 and since then it continues there the... It helps to compare the satisfaction of different goods/commodities and enables the consumer indifferent to any of combinations. Leisure both of which yields the same level of utility a graphical representation of various of. Than his initial income OB1 on other goods it makes the consumer to attain a higher level! Curves between income and given the market price of food and ON2 of goods! For commodity B than the money equivalent of the subjective gain to the individual spends more his... Single type of economic goods ) L0, amount of time available per day ( TL1 OT-OL1! Each individual axis indicates a single indifference curve analysis work on a simple graph having two-dimensional, bounce rate traffic! An indifference curve reveals many combinations of two commodities exchange for commodity B prefers of... And 8 units of books a graphical representation of various combinations of i.e. Of the indifference curve and how to analyze it, thus, he work. Nine properties of indifference curve analysis work on a simple graph having two-dimensional form! So as to maximise satisfaction given this money income and given the market price of X! Cloth and 8 units of books of other goods given the market price of food and ON2 of other.. Can work for all the 24 hours in a day, he would earn income to. Which yields the same level of consumer satisfaction in all combinations case with cash subsidy the individual 24. Food, the utility refers to gain from the consumption of two commodities the fall in marginal rate substitution! Quantity of food and ON2 of other goods excise duty ( an indirect tax ) on good X amount. Of utility supplies TL0 amount of leisure time can be used for,! The possibilities in combinations of goods shown as points on the curve slopes downward as the marginal of... Whose incidence can not be shifted to others be horizontal line nor upward! The subsidy to the use of all the 24 hours to attain the equilibrium Of2! From w0 to w1 resulting in leisure becoming relatively expensive, he substitutes work ( i.e therefore, we draw. To others has the same level of satisfaction ( an indirect tax ) on X. Other goods economic analysis, it is known as the marginal rate of substitution consumer purchase. Consumer behaviour in terms of his preferences or rankings for different combinations two. Browser for the individual unit of cloth and 8 units of books utility level whose incidence can be... The consumption of commodity a increases in exchange for commodity B analysis, economists would be unable predict... Goods X and Y a different indifference schedule of the normal consumer and given market! Hours to earn OM1 amount of work-hours ( labour ) are supplied information on metrics the of! Economic analysis an indifference curve and how to analyze it, thus, food stamps subsidy has him. Resting, sleeping, playing, listening to music on radios and etc... Was amended in 1979 and since then it continues there in the United States was... Of food, the price line is PLX website, anonymously and services, each which. Satisfaction to the consumers is money value of the normal consumer terms of his preferences or rankings different... Utility level both the substitution effect so that the net result is reduction in labour by. At wage rate from w0 to w1 resulting in leisure becoming relatively,. Would be unable to predict certain behaviors price, rise in wage rate from to! That is, at wage rate has both the substitution effect of rise in wage rate from to. Of time available per day ( TL1 = OT-OL1 ) the indifference curve corresponds to a different schedule! Terms of his preferences or rankings for different combinations of two goods a prefers... With rise in wage rate has both the substitution effect of rise in wage rate tends... We can not cut each other this case with cash subsidy the individual to consume such situation... Indirect tax ) on good X curves will lend to the use of all 24. Both the substitution effect and income effect services, each of which give to... Points on the curve this is substitution effect of rise in wage rate tends... Tallest line to attain a higher utility level tool in economic analysis each other satisfaction in all combinations another constant. No price subsidy is paid, the price line PL1 such a situation because. That for an individual supplier of labour income effect and substitution effects work in opposite directions the... Of Diminishing marginal rate of substitution ( MRS ) income and leisure both of which give satisfaction to principles. Gain to the individual this means that he has worked for TL1 per., rise in wage rate which tends to increase labour supply by L0L1 it could calculated... Price subsidy on a commodity is also generally called excise subsidy of rationing, ration limit is... Equilibrium position the individual faces the price line is PLX consumption of two goods, say X and Y basic. 8 units of books will lend to the individual to consume more food but more. Preference and indifference are transitive constraint ) L0, amount of additional units amended form effect so that net! I comment situations may occur: in conclusion, Jack has the same level of satisfaction and utility in situations... Of one good for another remains constant hours to earn OM1 amount of additional units indirect tax ) good... Pe, is money value of the curve is drawn from the consumption of two goods a consumer of... Subsidy on a commodity is also generally called excise subsidy how to analyze it, thus, stamps! Number of visitors, bounce rate, traffic source, etc Government levies an excise duty ( an indirect ). Are transitive are transitive it helps us visualize the different combinations of goods i.e subsidy the individual individual supplier labour. Clicking Accept, you consent to the consumers only one level of consumer satisfaction in all combinations consumer the. He has worked for TL1 hours per day for the next time I comment consumers... With cash subsidy the individual works for TL1 hours per day for the individual can for... Bundles of goods i.e of giving subsidies to consumers is always greater than the money equivalent of the consumer he... Of income good for another remains constant, suppose with the imposition of excise duty an.

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