Lastly, out of the two possibilities of the effects of food-stamp subsidy and cash subsidy which is the most common result, that is, the most common outcome of the two possible cases presented in Fig. If indifference curves were concave or straight lines, the consumer would succumb to monomania, that is, he would buy and consume only one good. An indifference curve is the locus of all those combinations of two goods that yields the same level of utility (satisfaction) to the consumer so that the consumer is indifferent to purchase the particular combination s/he selects. Assumptions of Indifference Curve. (12) The consumer is in a position to order all possible combinations of the two goods. 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. Straight-line indifference curves of perfect substitutes are shown m Fig. Thus, the slope of the income-leisure curve OM/OT equals the wage rate. Effect of Rationing On Consumers Welfare: Indifference curve analysis can be used to explain under what conditions rationing of goods by the Government can act as binding or a constraint on consumers choices and further how it affects his welfare. How the effect of rise in wage rate is split up into income effect and substitution effect is shown in Fig. In panel (b), the information supplied by the wage-offer curve, that is, the supply of labour (work-hours) by the individual at different wage rates is shown directly as, in this panel, supply of labour (hours worked) is measured along the X-axis and wage rate along the Y-axis. You also have the option to opt-out of these cookies. On the other hand, an indirect tax is one which can be passed on or shifted to others by raising the prices of the goods. AB is tangent to indifference curve IC1 at point S at which he supplies TL2 hours for work. 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. The slope of the curve at any given point represents utility for any combination of two goods. When a curve intersects the budget limit of an individual consumer, it creates an optimal consumption bundle. Save my name, email, and website in this browser for the next time I comment. . Privacy Policy3. (7) An indifference curve is negatively inclined sloping downward. Since the consumer cannot use food stamps to buy non-food items (other goods) he cannot spend more than his initial income OB1 on other goods. The budget line is tangent to indifference curve IC2 at point 'E'. The following points highlight the top nine properties of Indifference Curve. 11.19. They slope downward to the right, are convex to the origin and do not intersect. 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. 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. An indifference curve denotes a set of different combinations of two commodities or goods, providing the same level of satisfaction to the consumer. To do so we take away so much income from the individual that he comes back to the original indifference curve IC1. Indifference curves between income and leisure are therefore also called trade-off curves. 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. The theory of consumption is based on the scale of preference and the ordinal ranks or orders of one's preferences. 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. Since all the combinations give the same amount of satisfaction, the consumer prefers them equally. An indifference curve is a graphical representation of various combinations or consumption bundles of two commodities. Therefore, RM is also greater than PE. However, with AB as the price line, individual is in equilibrium at point Q2 on indifference curve IC2 which lies at a higher level than IC1. AB is such line obtained after reducing his money income by compensating variation. Content Filtrations 6. 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. 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. 200 he can therefore buy 20 kg of food which is equal to B1C at the given market price. This is illustrated in Fig. The indifference curve indicates the various combinations of two goods that yield equal satisfaction to the consumer. It makes the consumer indifferent to any of the combinations of goods shown as points on the curve. Consider Figure 11.15 where leisure is measured in the rightward direction along the horizontal axis and the maximum leisure time is OT (equal to 24 hours). Before publishing your articles on this site, please read the following pages: 1. Likewise, the combinations B and C will give equal satisfaction to the consumer; both being on the same indifference curve IC1. Further, he is better off than before as he is now at the higher indifference curve IC2. The cookie is used to store the user consent for the cookies in the category "Performance". Examples of goods that are perfect substitutes are not difficult to find in the real world. This cookie is set by GDPR Cookie Consent plugin. On the other hand in case of cash subsidy the government provides a lump sum cash income to the consumer. A higher indifference curves to the right of another represents a higher level of satisfaction and preferable combination of the two goods. Property IV: A higher indifference curve represents a higher level of satisfaction than a lower indifference curve: The last property of indifference curve is that a higher indifference curve will represent a higher level of satisfaction than a lower indifference curve. You can calculate it by, It is the income that serves as a binding on his consumption choice and not the ration limit. Theindifference curve in economicsexamines demand patterns for commodity combinations, budget constraints and helps understand customer preferences. This cookie is set by GDPR Cookie Consent plugin. In the curve, the quantity consumed by B2 will compensate for the increase in the amount consumed by B2. 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. Disclaimer Copyright, Share Your Knowledge Since lump-sum tax or any income tax does not alter the relative prices of goods it will not result in any substitution effect. Here we discuss the properties of the indifference curve and how to analyze it, along with examples and assumptions. Indifference curve must be convex to the origin: TM0 as budget constraint) L0, amount of work-hours (labour) are supplied. Since at the given market price of food, he can buy ,C amount of food with the food stamps of Rs. With equivalent food stamp subsidy of B1C the individual has to choose a point which must be on the kinked budget line B1CL2. Now, if substitution effect had been larger than income effect, work-hours supplied would have increased as a result of rise in wage rate. It indicates that the slope of the curve is negative. 1. This is directly plotted against the wage rate w0 in panel (b) of Fig. It Dispenses with Cardinal Measurement of Utility 2. 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. goods other than food). With the imposition of excise duty, the price of good X will rise. Thus, in this possibility, the effect of equivalent cash subsidy is exactly the same as the effect of food stamp subsidy. This is a substitution effect of the rise in wage rate tends to reduce leisure and increase labour supply (i.e. After reading this article you will learn about: 1. An important application of indifference curves is to judge the welfare effects of direct and indirect taxes on the individuals. 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. 200 per week which he can spend on food alone. Plagiarism Prevention 4. Thus the indifference curve I4 indicates a higher level of satisfaction than I3 which, in turn, is indicative of a higher level of satisfaction than I2 and so on. Let us suppose that the individual has OP money income. Wage offer Curve and the Supply of Labour: Now with the analysis of leisure-income choice, it is easy to derive supply curve of labour. When no price subsidy is paid, the individual faces the price line PL1. The farther the Indifference curve from the origin, then: 2. It helps us visualize the different combinations of goods and services, each of which yields the same level of utility. With stamps of Rs. 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. 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. 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. You also have the option to opt-out of these cookies. Answer (1 of 3): The following points highlight the top nine advantages of indifference curve technique over marshallian utility analysis. It provides equivalent satisfaction and utility levels for the consumer. less work-hours supplied). Pen and ink, right shoe and left shoe, automobile and petrol sauce and hamburger, type writer and typists are some examples of perfect complements. 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. 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. This is substitution effect of rise in wage rate which tends to increase labour supply by L0L1. 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. 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. 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. They may represent higher or lower satisfaction of the consumer. 200 he can buy 20 kg of food. 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). The less the ease with which two goods can be substituted for each other, the greater will be the fall in the marginal rate of substitution. 4 Important Properties of Indifference Curve (with curve diagram) - - StuDocu. Without this type of analysis, economists would be unable to predict certain behaviors . 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. The importance of indifference curve analysis to neoclassical microeconomic consumer theory can hardly be overstated. As noted above, combination H is not available under food stamp subsidy because food stamps cannot be used to purchase other goods. At the extreme, when two goods cannot at all be substituted for each other, that is, when the two goods are perfect complementary goods, as for example gasoline and coolant in a car, the indifference curve will consist of two straight lines with a right angle bent which is convex to the origin as shown in Fig. set of attainable combinations of two goods X and Y) as shown by the reduced shaded area in Figure 11.7 and therefore in this case the ration limit is only potentially binding on him. All other variables remain constant. We will now explain the consequences if both the commodities X and Y are rationed. 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. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. This has been a guide to What is Indifference Curve and its Definition. In other words, besides analysing consumers demand, indifference curves have several other applications. These cookies will be stored in your browser only with your consent. 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. . (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. 11.3. Some of the important problems are explained below with the help of this technique. Consumers would prefer to move in the direction indicated by the arrow in the figure. number of hours worked). If you enjoy both pizza and pasta, for example, you might not care whether you purchase 20 pizzas and no pasta . 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. Supply curve of labour shows how an individuals work effort responds to changes in the wage rate. 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. In other words, at point Q2 individuals level of welfare is higher than at Q1. (5) The consumers tastes, habits and income remain the same throughout the analysis. Now let us assume that he is given the cash subsidy of B1 B2 so that with the given market price of food, budget line shifts to B2L2. If the individual can work for all the 24 hours in a day, he would earn income equal to OM. What is indifference curve importance? Whereas income effect of the rise in wage rate tends to reduce supply of labour, substitution effect tends to increase it. However, it is important to note that he . An indifference curve is a graph showing combination of two goods that give the consumer equal satisfaction and utility. Share Your PPT File. It explains consumer behaviour in terms of his preferences or rankings for different combinations of two goods, say X and Y. It is evident from Fig. Also referred to as final products, examples of consumer goods include an Apple cellphone or a box of Oreo cookies. all of which provide satisfaction to the individual. The cookie is set by the GDPR Cookie Consent plugin and is used to store whether or not user has consented to the use of cookies. But opting out of some of these cookies may affect your browsing experience. 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. 11.19 that income effect is stronger than substitution effect so that the net result is reduction in labour supply by L0L1 work-hours. When the wage rate rises to W1 (budget constraint becomes TM1 in panel (a) of Fig. Login details for this Free course will be emailed to you. You may also have a look at the following articles to learn more , Your email address will not be published. On the other hand, an indirect tax not only reduces the purchasing power or real income of the consumer causing income effect, but also produces price-induced substitution effect and thus forcing him to purchase less of the commodity on which indirect tax has been levied and buy more of the non-taxed commodity. It does not store any personal data. (6) He prefers more of X to less of Y or more of Y to less of X. Another important result obtained from our above analysis is that even with food stamps programme the individual increases the consumption of all other goods (i.e. 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. We cannot predict the specific result purely on theoretical grounds. 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.
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