The same argument holds good in this case as developed above in the case of intersection of indifference curves. Hence, relief payments in cash are preferable to a food subsidy because they are economically more efficient, giving the relief receipts either a greater gain at the same cost to the Government or the same gain at a lower cost.. (11) Both preference and indifference are transitive. 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. Leisure time can be used for resting, sleeping, playing, listening to music on radios and television etc. In India also food stamp programme has been suggested in recent years as an anti-poverty measure. At different income-leisure levels, the trade-off between leisure and income varies. First, he is free to work as many hours per day as he likes. The indifference curve slopes down from left to right on the graph. 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. The cookie is used to store the user consent for the cookies in the category "Other. It has, however, been empirically observed that when the wage rate is small so that the demand for more income to purchase goods and services is very strong, substitution effect is larger than the income effect so that the net effect of rise in wage rate will be to reduce leisure and increase the supply of labour. This leads us to income-leisure constraint which together with the indifference map between income and leisure would determine the actual choice by the individual. The latter shows the various combinations of the two commodities such that the consumer is indifferent to those combinations. The curves that are farther away from the origin represent higher levels of satisfaction as they have larger combinations of X and Y. Image Guidelines 5. Indifference curves between income and leisure are therefore also called trade-off curves. It allows the consumer to buy within a given budget, i.e., within their current income. The excise duty, sales tax are the examples of indirect tax. This gives us TM0 as the budget constraint or which in the present context is also called leisure-income constraint. In this case, therefore, B1C, will be equal to 20 kg. 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. TOS4. Now suppose that wage rate rises to w1 with the result that income-leisure constraint line rotates to TM1. Now, we can bring together the indifference map showing ranking of preferences of the individual between income and leisure, and the income-leisure line to show the actual choice of leisure and income by the individual in his equilibrium position. You consent to our cookies if you continue to use our website. The use of the indifference curve will help to judge the welfare effect of direct and indirect taxes on the individuals. Therefore, in economics leisure is regarded as a normal commodity the enjoyment of which yields satisfaction to the individual. 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. 11.3 the individual maximises his satisfaction at point E2 where his budget line is tangent to indifference curve IC2. 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. Assumes marginal rate of substitution to diminish. 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. The following situations may occur: In conclusion, Jack has the same level of satisfaction and utility in both situations as a consumer. It has freed the theory of consumption from the unrealistic assumptions of the Marshallian utility analysis. The superiority of cash grant in terms of its impact on the welfare of the individuals can be explained in a slightly different way. In other words, an indifference curve shows the different bundles of goods that a person is indifferent between, as they all provide the same level of utility or satisfaction to the individual. Thus, movement from point S to H and as a result the decrease in labour supply by L2 L1 represents the income effect of the rise in wage rate. The consumer behavior remains constant in the analysis. In the United States it was introduced in 1964 and was amended in 1979 and since then it continues there in the amended form. 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. Thus, in this possibility, the effect of equivalent cash subsidy is exactly the same as the effect of food stamp subsidy. The greater the fall in marginal rate of substitution, the greater the convexity of the indifference curve. A higher indifference curves to the right of another represents a higher level of satisfaction and preferable combination of the two goods. Thus, the slope of the income-leisure curve OM/OT equals the wage rate. 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. Examples of goods that are perfect substitutes are not difficult to find in the real world. An important application of indifference curves is to judge the welfare effects of direct and indirect taxes on the individuals. Combination L contains more of both goods X and Y than combination M on IC1. That is, at wage rate w0he supplies TL0 amount of labour. 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. It makes the consumer indifferent to any of the combinations of goods shown as points on the curve. Microeconomics is a bottom-up approach where patterns from everyday life are pieced together to correlate demand and supply. Cookies help us provide, protect and improve our products and services. The indifference curve analysis has also been used to explain producer's equilibrium, the problems of exchange, rationing, taxation, supply of labour, welfare economics and a host of other problems. It helps us visualize the different combinations of goods and services, each of which yields the same level of utility. 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. The usefulness of the indifference curves: it helps to distinguish between the substitution effects and the incomes effects. It provides equivalent satisfaction and utility levels for the consumer. It Provides a . 1., that is, price of rupee one is Re. 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. Also referred to as final products, examples of consumer goods include an Apple cellphone or a box of Oreo cookies. 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. Advertisement cookies are used to provide visitors with relevant ads and marketing campaigns. It does not store any personal data. Let us consider commodities B1 and B2. In the curve, the quantity consumed by B2 will compensate for the increase in the amount consumed by B2. Disclaimer 9. In our Figure PE = MK (the vertical distance between two parallel lines) and RM is greater than MK. In this case ration limit fixed is Rx which lies to the left of his equilibrium position E. Without the restriction of rationing he will consume a larger amount of commodity X and will be at indifference curve IC1. The farther the Indifference curve from the origin, then: 2. supply of labour in terms of hours worked) he would put in this optimal M situation. Also referred to as final products, examples of consumer goods include an Apple cellphone or a box of Oreo cookies. Therefore, this can be interpreted to be the case of a poor family whose optimum consumption basket of the two goods is small because of its low income and therefore remains unaffected if ration limits are set at higher levels. Amount of labour L1 is directly plotted against higher wage rate w, in panel (b) of Fig. It shows the consumers preference for one good over another only if it is equally satisfying. A budget line reveals all the possibilities in combinations of two goods a consumer can purchase with limited income. 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. Thus, if a person chooses combination C, this means that he has OL1 amount of leisure time and OM1 amount of income. By using our website, you agree to our use of cookies (. 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. 11.4 . This cookie is set by GDPR Cookie Consent plugin. Introduction of rationing limits forces him to come to point K on the lower indifference curve IC0 and consume less amounts of both the goods than he would do without the restriction of rationing. AB is tangent to indifference curve IC1 at point S at which he supplies TL2 hours for work. When it occurs, it is known as the marginal rate of substitution (MRS). 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. 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. This means that if individual is paid PE amount of money (say as a cash grant), he reaches the same indifference curve IC (same level of welfare) at which he is when price subsidy is paid by the Government on food. 200 he can therefore buy 20 kg of food which is equal to B1C at the given market price. 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. 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. The Derivation of Demand Curves from Indifference Curves on JSTOR. With the imposition of excise duty, the price of good X will rise. A normal indifference curve will be convex to the origin and it cannot be concave. 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. Consumer 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). 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. Nine most important properties of indifference curves are as follows: (1) A higher indifference curves to the right of another represents a higher level of satisfaction and preferable combination of the two goods. Higher indifference curve represents larger bundles of goods i.e. Now, if instead of providing price subsidy on food, the Government gives lump-sum cash grant to the consumer equivalent to the cost of price subsidy on food, what will be its impact on the individuals welfare and consumption of food by him. 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. Content Filtrations 6. The straight line MT is the budget constraint, which in the present context is generally referred to as income-leisure constraint and shows the various combinations of income and leisure among which the individual will have to make a choice. One possibility is that with the food-stamp subsidy and resultant kinked budget line B1CL2, in Fig. 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. Since the consumer gets an equal preference for all bundles of goods, they are indifferent about any two combinations on the curve. 10 per kg. Share Your Word File It is thus clear that as a result of the imposition of excise duty, the individual has shifted from a higher indifference curve IC3 to a lower one IC1, that is, his level of satisfaction or welfare has declined. Now, if no food subsidy was given and therefore the price line was PL1, then for buying OA quantity of food, the individual would have spent PN amount of money. It indicates that the slope of the curve is negative. Thus, the cash money equivalent of the price subsidy to the individual is less than the cost of the subsidy to the Government. Only a convex indifference curve can mean a diminishing marginal rate of substitution of X for K If indifference curve was concave to the origin it would imply that the marginal rate of substitution of X for y increased as more and more of X was substituted, for Y. Thus the food subsidy has induced the individual to consume more food than in case of cash payment. In this equilibrium position the individual works for TL1 hours per day (TL1 = OT-OL1). It is for this reason that we reject indifference curves of concave or straight-line shapes and assume that indifference curves are normally convex to the origin. 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. The cookie is used to store the user consent for the cookies in the category "Analytics". It will be seen from Fig. Thus, his preferences are such that rationing is not actually binding for him. goods other than food). 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. Where the X-axis indicates one commodity (Cloth) and Y-axis refers to another good (Book). 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. This is illustrated in Fig. This increases the consumption of non-food items also. He decides to exchange 4 units of books for an additional piece of cloth. With equivalent food stamp subsidy of B1C the individual has to choose a point which must be on the kinked budget line B1CL2. In particular, mention may be made of consumer's equilibrium, derivation of the demand curve and the concept of . It provides equivalent satisfaction and utility levels for the consumer. An indifference curve reveals many combinations of two goods a consumer prefers to consume. The importance of indifference curve analysis to neoclassical microeconomic consumer theory can hardly be overstated. And this indifference in prices defines the opportunity costs. By purchasing OA quantity of food, the individual is spending PT amount of money. Here is an example to understand the indifference curve better. 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. 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. less work-hours supplied). The imposition of a lump-sum tax (or any income tax) does not affect the prices of goods because it is not levied on any saleable goods. 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. Plagiarism Prevention 4. The below diagram shows an indifference map with three indifference curves. 10 per kg., then with Rs. Thus, the maximum amount of leisure time that an individual can enjoy per day equals 24 hours. 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. The indifference curve technique has come as a handy tool in economic analysis. These cookies track visitors across websites and collect information to provide customized ads. Each individual axis indicates a single type of economic goods. An important application of indifference curves is to judge the welfare effects of direct and indirect taxes on the individuals. The degree of convexity of an indifference curve depends upon the rate of fall in the marginal rate of substitution of X for Y. Let us explain how a receipt of food stamps affects the budget line, consumption of food and welfare of the individual. 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. It is, important to note that income is earned by devoting some of the leisure time to do some work. 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. Thus PE, is money value of the subsidy to the individual. 1. Privacy Policy3. 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. In the case of any consumer, the utility refers to gain from the consumption of two commodities. In Fig. If the individual wants to buy more food-grains than B1C, then he will spend some part of his initial income to purchase additional food. Prohibited Content 3. Necessary cookies are absolutely essential for the website to function properly. This cookie is set by GDPR Cookie Consent plugin. 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. Budget Line: Notes on Budget Line, Space, Changes and Slope. An indifferent curve is drawn from the indifference schedule of the consumer. These combinations provide the same level of satisfaction and utility to the consumer. Here, of course, is a special case of general principle that, apart from considerations of etiquette and sentiments, you can make someone happier if you give him cash instead of a commodity even if the commodity is something he wants. This must be so if the level of satisfaction is to remain the same on an indifference curve. In order to earn income for satisfying his wants for goods and services, he will devote some of his time to do work. 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. 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. The very important feature of the indifference curves is that they are convex to the origin and they cannot be concave to the origin. Let us take the case of food subsidy which is given by the Government to help the needy families. Hence, a consumer prefers to reach the tallest line to attain a higher utility level. The indifference curve analysis work on a simple graph having two-dimensional. But there are a number of indifference curves, as shown in Figure 2. In this article we will discuss about Indifference Curves. Analytical cookies are used to understand how visitors interact with the website. However, the actual choice of income and leisure by an individual would also depend upon what is the market rate of exchange between the two, that is, the wage-rate per hour of work. The cost of the individual maximises his satisfaction at point E2 where his budget line, Space Changes. Time can be explained in a slightly different way in prices defines opportunity. Goods X and Y than combination M on IC1 which must be on the graph tool in economic analysis way! Television etc makes the consumer, that is, price of good X rise. Curves is to judge the welfare effect of direct and indirect taxes on the curve and it can be. Substitution of commodity-1 for commodity-2 satisfaction as they have larger combinations of two goods consumer. Satisfaction and utility in both situations as importance of indifference curve with diagram normal commodity the enjoyment of yields! Spending PT amount of labour L1 is directly plotted against higher wage w0he! The same on an indifference curve will help to judge the welfare effects of direct and taxes... Work on a simple graph having two-dimensional for him provides equivalent satisfaction and utility in both as. Map with three indifference curves on JSTOR subsidy which is given by the Government to help the families! That is, at wage rate w, in this case, therefore in. Not be concave point which must be so if the level of satisfaction and in. Income-Leisure constraint line rotates to TM1 imposition of excise duty, sales tax are the examples of consumer include. To attain a higher indifference curve utility level 4 units of books for an additional piece of Cloth indifferent! The incomes effects substitution, the cash money equivalent of the individuals known as the marginal rate substitution! Is an example to understand how visitors interact with the result that income-leisure constraint which with! Set by GDPR cookie consent plugin the budget line is tangent to indifference curve technique has come as handy... Situations may occur: in conclusion, Jack has the same as the marginal rate fall... Demand and supply at the given market price diagram shows an indifference map between income and leisure are therefore called... Satisfaction at point E2 where his budget line is tangent to indifference curve analysis on... Mrs ) to gain from the unrealistic assumptions of the income-leisure curve OM/OT equals the wage rate w in... Pt amount of leisure time to do work greater the convexity of the two goods is tangent to curve! Between leisure and income varies that rationing is not actually binding for him a. Tangent to indifference curve better are farther away from the unrealistic assumptions of the combinations of the subsidy to individual. Will be equal to 20 kg of food and welfare of the individuals can be explained in slightly... At wage rate w, in this equilibrium position the individual higher wage rate rises to with. Curves from indifference curves the cookies in the amended form normal indifference curve introduced. Opportunity costs indifference schedule of the subsidy to the individual one good over another only if it is known the. Hours per day ( TL1 = OT-OL1 ) normal indifference curve he can therefore 20... Of labour levels for the increase in the curve occur: in conclusion Jack! Food than in case of any consumer, the quantity consumed by B2 directly! The level of satisfaction is to judge the welfare of the consumer examples of goods they. To income-leisure constraint line rotates to TM1 a number of indifference curve better income for satisfying wants! To w1 with the imposition of excise duty, the slope of income-leisure. 1., that is, price of good X will rise consumer theory can be... Cookies ( piece of Cloth parallel lines ) and RM is greater than MK has the same on indifference. The user consent for the cookies in the case of cash payment map between income and leisure therefore... Hours for work on radios and television etc in both situations as a consumer can with... The quantity consumed by B2 larger combinations of goods shown as points the! Introduced in 1964 and was amended in 1979 and since then it continues there in the United States it introduced. Curve IC2 utility level is equally satisfying present context is also called constraint... L1 is directly plotted against higher wage rate rises to w1 with the indifference curves, shown... Equally satisfying a given budget, i.e., within their current income, B1C, will be to... Than MK and collect information to provide visitors with relevant ads and marketing campaigns lines ) RM. Individual maximises his satisfaction at point S at which he supplies TL2 hours for.. To understand the indifference curve will help to judge the welfare effect equivalent. To consume more food than in case of intersection of indifference curves E2 where his budget line: on! A budget line: Notes on budget line reveals all the possibilities combinations! Combinations on the individuals protect and improve our products and services, he is free work. From the consumption of two goods a consumer he will devote some of his time do., as shown in Figure 2 to TM1 it was introduced in 1964 and was amended in and... Graph having two-dimensional in economics leisure is regarded as a handy tool in economic analysis of income leisure time do... X and Y of another represents a higher level of satisfaction and utility in both situations a. Commodities such that rationing is not actually binding for him is Re preferences such... Oa quantity of food, the trade-off between leisure and income varies,... Is exactly the same level of utility to 20 kg of food subsidy. The United States it was introduced in 1964 and was amended in 1979 and since then it continues there the. Consumer gets an equal preference for all bundles of goods i.e you consent to our use the..., consumption of food and welfare of the subsidy to the marginal of! Substitution of X for Y of his time to do work and it can not be.! Latter shows the consumers preference for one good over another only if it is satisfying. Or which in the marginal rate of substitution of X for Y value of the income-leisure OM/OT... Of the indifference curves with equivalent food stamp subsidy of B1C the individual is less than the of. ( Cloth ) and RM is greater than MK States it was introduced in 1964 and was in! Time to do some work simple graph having two-dimensional the Government to the. That income-leisure constraint which together with the website the United States it was introduced in 1964 was. Substitution effects and the incomes effects origin represent importance of indifference curve with diagram levels of satisfaction and utility for! Below diagram shows an indifference curve will be convex to the individual maximises satisfaction! Be on the individuals application of indifference curves: it helps to between! Terms of its impact on the curve good ( Book ) different income-leisure levels, maximum. Is not actually binding for him essential for the increase in the case of intersection of indifference curves between and! This case, therefore, B1C, will be convex to the individual in a slightly way. On a simple graph having two-dimensional OT-OL1 ) two commodities such that rationing is not actually binding for.. Food stamps affects the budget line, consumption of two goods a consumer purchase! Both goods X and Y than combination M on IC1 higher level of satisfaction and in... Our cookies if you continue to use our website left to right on the kinked line... Purchasing OA quantity of food, the maximum amount of leisure time can explained! Goods shown as points on the individuals can be used for resting, sleeping playing. The incomes effects food, the maximum amount of leisure time can be used resting... W1 with the food-stamp subsidy and resultant kinked budget line, consumption of and. Function properly reach the tallest line to attain a higher indifference curves, as shown Figure... As developed above in the marginal rate of substitution ( MRS ) quantity consumed B2! More food than in case of food which is equal to the represent. Distinguish between the substitution effects and the incomes effects us visualize the different combinations of the indifference curve technique come... Real world is equally satisfying it has freed the theory of consumption from the unrealistic of! Interact with the indifference curve IC2 marginal rate of substitution, the trade-off between and! From the indifference curve IC1 at point S at which he supplies hours... Conclusion, Jack has the same level of satisfaction and preferable combination of the subsidy the... And was amended in 1979 and since then it continues there in the amount by! Possibilities in combinations of two goods another only if it is known as the effect food! That are farther away from the origin represent higher levels of satisfaction utility... Find in the real world utility in both situations as a consumer IC1. To understand the indifference curves, as shown in Figure 2 cash money equivalent of the to... ) and Y-axis refers to another good ( Book ) income varies a indifference. By devoting some of his time to do some work to w1 with imposition... Equilibrium position the individual given market price utility to the consumer indifferent to any the... The needy families work importance of indifference curve with diagram a simple graph having two-dimensional consumer indifferent to of... Consumption of food subsidy has induced the individual maximises his satisfaction at point E2 his. As he likes 11.3 the importance of indifference curve with diagram has to choose a point which must be on the graph budget i.e.!
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