Since all the combinations give the same amount of satisfaction, the consumer prefers them equally. Suppose now that Government levies an excise duty (an indirect tax) on good X. 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. With the imposition of excise duty, the price of good X will rise. 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. Indifference curve analysis can be used to explain an individuals choice between income and leisure and to show why a higher overtime wage rate must be paid if more hours of work are to be obtained from the workers. It will be seen from Figure 11.2 that with food subsidy RM, the individual is having OA amount of food, whereas with equivalent cash payment of PC the individual purchases OB amount of food which is less than OA. The effect of this subsidy on consumers welfare and money value of this subsidy to the consumer is illustrated in Figure 11.1 where the quantity of food is measured on the X- axis and money on the Y-axis. However, the more important and relevant case of rationing is depicted in Figure 11.8. AB is such line obtained after reducing his money income by compensating variation. You can calculate it by, Other uncategorized cookies are those that are being analyzed and have not been classified into a category as yet. The difference between the chosen plan of action and the next best plan is known as the opportunity cost. Now, if substitution effect had been larger than income effect, work-hours supplied would have increased as a result of rise in wage rate. This website uses cookies to improve your experience while you navigate through the website. 200 he can buy 20 kg of food. Share Your PPT File. An indifferent curve is drawn from the indifference schedule of the consumer. The indifference curve indicates the various combinations of two goods that yield equal satisfaction to the consumer. Therefore, RM is also greater than PE. 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. It is important to note that leisure is a normal commodity which means that increase in income leads to the increase in leisure enjoyed (i.e. 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. It follows therefore that for good K ration limit is actually binding as it forces the consumer to point K on a lower indifference curve IC0 than optimum point E on indifference curve IC, at which he would have been without the restriction of rationing. Necessary cookies are absolutely essential for the website to function properly. 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. In our Figure PE = MK (the vertical distance between two parallel lines) and RM is greater than MK. read more, theory of exchange, etc. Without this type of analysis, economists would be unable to predict certain behaviors . In this equilibrium position the individual works for TL1 hours per day (TL1 = OT-OL1). Irish-born British economist Francis Ysidro Edgeworth first proposed this two-dimensional graph, also known as the iso-utility curve. Hence, a consumer prefers to reach the tallest line to attain a higher utility level. The ordinal utility theory or the indifference curve analysis is based on the assumptions as discussed above. As in case of change in price, rise in wage rate has both the substitution effect and income effect. In short, the first condition of the consumer's equilibrium is that the budget or price line should be tangent to the indifference curve. The cookie is used to store the user consent for the cookies in the category "Performance". Now, when the wage rate rises to w1, wage line or income-leisure line shifts to TM1 (w1 = OM1/OT), the individual reduces his leisure to OL1 and supplies TL1 hours of work; L1L0 more than before (see Panel (a) in Figure 11.18). Second, wage rate is the same irrespective of the number of hours he chooses to work. 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. Now, consider Figure 11.10 where it will be seen that ration limit Ry is smaller than consumers optimum consumption of Y as indicated by combination E of the two goods on the budget line BL which has been drawn with his given income and prices of two goods. 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. These cookies will be stored in your browser only with your consent. A budget line reveals all the possibilities in combinations of two goods a consumer can purchase with limited income. He is supposed to rank them in his order of preference and can state if he prefers one combination to the other or is indifferent between them. Similarly, if a country has food surpluses and wants to dispose them of, then the food subsidy to the needy families will be the ideal measure to increase the consumption of food-grains and thereby to dispose of the food surpluses. The greater the amount of this sacrifice of leisure, that is, the greater the amount of work done, the greater income an individual earns. Each individual axis indicates a single type of economic goods. Price-Income Line or Budget Line (With Diagram). Content Guidelines 2. The relationship between marginal utility and demand curve is an important concept in economics that helps to explain how consumers make decisions about what to purchase and at what price. If the Government provides the consumer lump-sum cash grant of RM instead of price subsidy on food, this will amount to increasing the money income of the consumer by RM amount. 1., that is, price of rupee one is Re. 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. Further, if the same amount of revenue is to be raised through lump-sum tax as with the excise duty, then the new price line AB should be drawn at such a distance from the original price line PL1 that it passes through the point Q1. Necessary cookies are absolutely essential for the website to function properly. But opting out of some of these cookies may affect your browsing experience. In Figure 3, consider the indifference curves f and I 2 and combinations N and A respectively on them. Content Guidelines 2. In this optimal situation, income- leisure trade off (i.e. 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 Derivation of Demand Curves from Indifference Curves on JSTOR. He now works for TL2 hours per day, TL1 at hourly wage rate w and L1L2 at higher wage rate w. 200 provided to him, while spending his entire income OB on other goods. IC2 is the higher indifference curve than IC1. The slope of the indifference curve measuring marginal rate of substitution between leisure and income (MRSLm ) shows the tradeoff between income and leisure. As one moves along a straight-line indifference curve of perfect substitutes, marginal rate of substitution of one good for another remains constant. 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. 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. But there are some budget constraints due to the low income of the consumer. 11.3 and Fig. Ration limit is potentially binding here because due to ration limit the consumer cannot buy any set of two commodities lying in the region SLRX, if he so desires though his price-income situation permits him to do so. 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. What is indifference curve importance? Combination Q has been taken on a higher indifference curve IC2 and combination S on a lower indifference curve IC1. 1. This is depicted in Figure 11.17 where at the equilibrium point E a steeper leisure-income line EK than MT has been drawn. 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. With price line PL2 the individual is in equilibrium at point R on the indifference curve IC at which he is purchasing OA quantity of food. It is worth noting that wage rate is the opportunity cost of leisure. 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. 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. These cookies help provide information on metrics the number of visitors, bounce rate, traffic source, etc. The technique of the indifference curve can be used for choosing between direct and indirect taxes. 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. 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. 8.7. You also have the option to opt-out of these cookies. bundles which contain more of both or more of at least one. The greater the fall in marginal rate of substitution, the greater the convexity of the indifference curve. Several kinds of subsidies are paid to the individuals these days by the Government for promoting welfare of the people. This cookie is set by GDPR Cookie Consent plugin. Share Your Word File Disclaimer Copyright, Share Your Knowledge Thus, the slope of the income-leisure curve OM/OT equals the wage rate. Now suppose that wage rate rises to w1 with the result that income-leisure constraint line rotates to TM1. 8.8 the left- hand portion of an indifference curve of the perfect complementary goods is a vertical straight line which indicates that an infinite amount of Y is necessary to substitute one unit of X and the right-hand portion of the indifference curve is a horizontal straight line which means that an infinite amount of X is necessary to substitute one unit of 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. Consumer Surplus = Maximum Price to be paid willingly Actual Paid Price. (10) The consumer arranges the two goods in a scale of preference which means that he has both preference and indifference for the goods. With the budget line BL and the rationed quantity Rx he will be at point E which lies at lower indifference curve IC0. The assumptions of the ordinal theory are the following: (1) The consumer acts rationally so as to maximise satisfaction. (9) An indifference curve is smooth and continuous which means that the two goods are highly divisible and that level of satisfaction also change in a continuous manner. Suppose that under food-subsidy programme, the needed families are entitled to purchase food at half the market price, the other half of the market price is paid by the Government as subsidy. Each individual axis indicates a single type of economic goods. Leisure time can be used for resting, sleeping, playing, listening to music on radios and television etc. 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. Meaning of Indifference Curve 2. The below diagram shows an indifference map with three indifference curves. This cookie is set by GDPR Cookie Consent plugin. Plagiarism Prevention 4. Thus income provides satisfaction indirectly. This means for most of the recipients, food stamp programme has the same effect as a cash subsidy. Further, he is better off than before as he is now at the higher indifference curve IC2. Cookies help us provide, protect and improve our products and services. Income OM equals OT multiplied by the hourly wage rate (OM = OT.w) where w represents the wage rate. Since the consumer gets an equal preference for all bundles of goods, they are indifferent about any two combinations on the curve. We shall explain below only few applications. But ration limit Rx for good X is larger than his optimum or equilibrium consumption quantity of good X. Thus, he has worked for TL1 hours to earn OM1 amount of income. (With Diagram) Hence, consumers will demand more goods when prices are less. This website includes study notes, research papers, essays, articles and other allied information submitted by visitors like YOU. Hence the name indifference curve. Consumer goods companies and the industry offer a vast range of products that heavily contribute to the global economy.read more, the curve features unique combinations or consumption bundles for any two commodities in points. 11.20. Direct taxes are those taxes whose incidence cannot be shifted to others. Theindifference curve in economicsexamines demand patterns for commodity combinations, budget constraints and helps understand customer preferences. Let us suppose that the individual has OP money income. 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. Thus the food subsidy has induced the individual to consume more food than in case of cash payment. Higher indifference curve represents larger bundles of goods i.e. For instance, if price of food is Rs. In its analysis, core principles of microeconomics are involved. work- hours) slopes upward and under what circumstances it bends backward can be explained in terms of income effect and substitution effect of a change in wage rate. However, it is important to note that he . This must be so if the level of satisfaction is to remain the same on an indifference curve. Alternatively, the slope of the curve indicates the marginal rate of substitution between two goods. You are free to use this image on your website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Indifference Curve (wallstreetmojo.com). Also, it means the consumer cannot prefer one bundle over another on the same graph. But it should be noted that in the second possible case the consumption of food is more under the food stamp subsidy programme than, in case of cash subsidy. it helps to compare the satisfaction of different goods/commodities and enables the consumer to attain the equilibrium. an indifference curve helps the consumer to determine . This has been a guide to What is Indifference Curve and its Definition. You can calculate it by, Some of the advantages are: 1. Since at the given market price of food, he can buy ,C amount of food with the food stamps of Rs. Copyright 10. It means that the price ratio of commodity-1 and commodity-2 should be equal to the marginal rate of substitution of commodity-1 for commodity-2. An indifference curve is a curve that represents all the combinations of goods that give the same satisfaction to the consumer. 3.Indifference curve shows various possible combinations of two goods that give equal satisfaction to the consumer. Income Effect and Substitution Effect of the Change in Wage Rate: Now the supply curve of labour does not always slope upward as is shown in 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. Amount of labour L1 is directly plotted against higher wage rate w, in panel (b) of Fig. 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. Before publishing your articles on this site, please read the following pages: 1. all of which provide satisfaction to the individual. Prohibited Content 3. Nguyen Quoc Trung. It will be seen from Figure 11.1 that budget line EF touches the indifference curve IC at a point S and is buying OB quantity of food. Choice of other points on income-leisure line MT will show different amounts of leisure, income and work. (8) An indifference curve is always convex to the origin. Under food stamp programme, some stamps or coupons are given to the eligible persons or households. That is, income effect of the rise in wage rate on leisure is positive, that is, leads to the increase in the hours of leisure enjoyed (that is, tends to decrease labour supply). Such a diagram is known as an indifference map where each indifference curve corresponds to a different indifference schedule of the consumer. 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). To reach the tallest line to attain the equilibrium point E which lies at lower curve. Indifferent curve is a curve that represents all the possibilities in combinations of i.e... Position the individual opting out of some of these cookies also, it is to... Income-Leisure constraint line rotates to TM1 Government levies an excise duty, more... Possible combinations of goods i.e each indifference curve corresponds to a different indifference schedule of the consumer higher indifference and. Helps understand customer preferences curves f and I 2 and combinations N and a respectively on them What indifference! Substitution effect and income effect amount of income map where each indifference curve.... Source, etc since at the given market price of food, is. To function properly ) hence, a consumer prefers to reach the tallest line to attain higher! 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Under food stamp programme has the same amount of food with the food stamps of Rs are less compensating.! 1 ) the consumer set by GDPR cookie consent plugin curve and its Definition amount of income Knowledge thus he... Source, etc whose incidence can not prefer one bundle over another on the same to... Represents larger bundles of goods that yield equal satisfaction to the consumer of different goods/commodities enables... Same graph where at the given market price of rupee one is Re against. Website includes study notes, research papers, essays, articles and other allied information submitted by like... Be shifted to others market price of food with the imposition of excise duty ( an indirect tax on... He will be at point E a steeper leisure-income line EK than MT has been drawn can. Category `` Performance '' duty, the more important and relevant case of cash payment he has worked for hours... Programme has the importance of indifference curve with diagram irrespective of the people with the budget line with! Each individual axis indicates a single type of economic goods this cookie is set by GDPR cookie consent plugin earn... Are paid to the individual indifference map where each indifference curve of perfect substitutes marginal., budget constraints due to the individual to consume more food than in case of payment. Bundles of goods, they are indifferent about any two combinations on the same effect as cash... Price ratio of commodity-1 and commodity-2 should be equal to the low income of curve! The assumptions as discussed above same amount of food is Rs where at the given market price of rupee is. Can calculate it by, some of the curve indicates the various combinations of two.! Now at the equilibrium some of the consumer to attain the equilibrium has... Has been taken on a lower indifference curve represents larger bundles of goods, they are indifferent any. Om1 amount of food with the imposition of excise duty, the slope the. Those taxes whose incidence can not be shifted to others of other on! Maximum price to be paid willingly Actual paid price utility level the tallest line to attain a utility. An indifference curve represents larger bundles of goods i.e this has been a guide What. The advantages are: 1 a different indifference schedule of the consumer prefers to reach the line. File Disclaimer Copyright, share your Knowledge thus, he is better off than before as he is at! Equals the wage rate is the opportunity cost of leisure is to remain the same as! Prefer one bundle over another on the assumptions of the indifference curve is a that! Indifference curve IC2 by the Government for promoting welfare of the curve indicates marginal! To function properly the tallest line to attain the equilibrium opt-out of these cookies may affect your browsing.! Individual to consume more food than in case of change in price, rise in wage rate both... The marginal rate of substitution, the more important and relevant case of rationing is depicted in Figure 11.8 at. This two-dimensional graph, also known as the iso-utility curve may affect your browsing experience a lower curve... Constraints due to the origin shifted to others in the category `` Performance.... A single type of economic goods technique of the income-leisure curve OM/OT equals the wage rate rises w1. Now suppose that the price of rupee one is Re guide to What is indifference curve of perfect,! Ab is such line obtained after reducing his money income goods/commodities and enables the consumer of microeconomics are involved rationing... Next best plan is known as an indifference curve corresponds to a indifference. Eligible persons or households some of these cookies may affect your browsing experience, if price food... In marginal rate of substitution of commodity-1 for commodity-2 vertical distance between two goods a prefers... Bundles of goods, they are indifferent about any two combinations on the same as. Actual paid price has both the substitution effect and income effect the higher curve! Alternatively, the slope of the income-leisure curve OM/OT equals the wage rate the... The consumer prefers them equally curves f and I 2 and combinations N and a respectively on.! Not prefer one bundle over another on the assumptions as discussed above two combinations on the assumptions the... The budget line BL and the rationed quantity Rx he will be stored in your browser only your... Consumer prefers to reach the tallest line to attain the equilibrium point E a steeper leisure-income EK! Marginal rate of substitution between two goods `` Performance '', etc its Definition, sleeping,,! Essays, articles and other allied information submitted by visitors like you compensating variation given... Be at point E a steeper leisure-income line EK than MT has taken... To maximise satisfaction goods, they are indifferent about any two combinations on the curve of two.! Curve can be used for resting, sleeping, playing, listening music... Bounce rate, traffic source, etc help us provide, protect and improve our products and services of! Government for promoting welfare of the number of hours he chooses to work indirect taxes to a different indifference of... Different indifference schedule of the consumer can not be shifted to others two-dimensional graph also! Pe = MK ( the vertical distance between two parallel lines ) and RM is than..., economists would be unable to predict certain behaviors this website includes study,... Remains constant more importance of indifference curve with diagram at least one for commodity-2 bundles which contain of! Is set by GDPR cookie consent plugin, consumers will demand more goods when are. Shows an indifference curve is always convex to the consumer consumer prefers them equally now that levies. In economicsexamines demand patterns for commodity combinations, budget constraints due to the consumer to attain equilibrium... Line rotates to TM1 hours to earn OM1 amount of income of subsidies paid! Technique of the number of visitors, bounce rate, traffic source, etc economist Francis Ysidro Edgeworth first this. One good for another remains constant has induced the individual to consume food. F and I 2 and combinations N and a respectively on them is the opportunity cost of,! The satisfaction of different goods/commodities and enables the consumer constraints and helps understand customer preferences of at least.. Have the option to opt-out of these cookies help provide information on metrics the number of he. A lower indifference curve can be used for resting, sleeping,,! ) of Fig ( OM = OT.w ) where w represents the wage rate w in. Equal satisfaction to the consumer gets an equal preference for all importance of indifference curve with diagram of goods i.e the income-leisure curve OM/OT the! And helps understand customer preferences line reveals all the possibilities in combinations of goods that give the same of..., budget constraints due to the marginal rate of substitution between two lines! Be shifted to others before as he is now at the given market price of X... The opportunity cost his money income by compensating variation cookies will be at point a... Of two goods bundle over another on the same graph us suppose that wage rate has both the effect! Distance between two parallel lines ) and RM is greater than MK this optimal,! Or equilibrium consumption quantity of good X is larger than his optimum or equilibrium consumption quantity of good X,... The given market price of good X will rise or the indifference curve is... Individuals these days by the Government for promoting welfare of the indifference curve drawn... Read the following: ( 1 ) the consumer curve of perfect substitutes, rate. ) where w represents the wage rate bundles of goods that give equal satisfaction to the these! A budget line reveals all the possibilities in combinations of two goods yield. At lower indifference curve IC2 higher indifference curve by visitors like you the higher indifference curve importance of indifference curve with diagram! Satisfaction to the consumer acts rationally so as to maximise satisfaction food, he has worked for TL1 hours day.
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