A normal indifference curve will be convex to the origin and it cannot be concave. Thus, with the rise in wage rate above W1,labour supply decreases. Amount of labour L1 is directly plotted against higher wage rate w, in panel (b) of Fig. Our assumption regarding diminishing MRSxy and the convexity of indifference curves is based upon the observation of actual behaviour of the normal consumer. Prior to grant of any subsidy, and given his budget line B1L1 the individual is in equilibrium at point E1 on indifference curve IC1. You consent to our cookies if you continue to use our website. In the following schedule (Table 1), the consumer is indifferent whether he buys the first combination of units of 18Y+1 unit of X or the fifth combination of 4 units of Y+5 units of X or any other combination. The cookie is set by GDPR cookie consent to record the user consent for the cookies in the category "Functional". 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. As in case of change in price, rise in wage rate has both the substitution effect and income effect. Thus, indifference curves have been used to explain the concept of consumers surplus, substitutability and complementarity of goods, supply curve of labour of an individual, several principles of welfare economics, burden of different forms of taxation, gain from foreign trade, welfare implications of subsidy granted by the Government, index number problem, mutual advantage of exchange of goods between two individuals and several other things. An indifference curve is a graphical representation of various combinations or consumption bundles of two commodities. 200 provided to him, while spending his entire income OB on other goods. The ordinal utility theory or the indifference curve analysis is based on the assumptions as discussed above. 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. An indifference curve has a negative slope, i.e. 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. 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. It is assumed that consumers preferences are monotonic i.e. 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. But there are a number of indifference curves, as shown in Figure 2. The latter shows the various combinations of the two commodities such that the consumer is indifferent to those combinations. When it occurs, it is known as the marginal rate of substitution (MRS). But there are some budget constraints due to the low income of the consumer. 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.. labour supply) L0L2 for leisure. We also use third-party cookies that help us analyze and understand how you use this website. Further, these stamps cannot be traded or transferred to the other people. 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. With stamps of Rs. The technique of indifference curves has been used not only to explain consumers behaviour and demand but also to analyse and explain several other economic problems. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. 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 preference-maximising point A on indifference curve I 1 shows that . 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. These combinations provide the same level of satisfaction and utility to the consumer. 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. Jack is satisfied with 1 unit of cloth and 8 units of books. 10 per kg., then with Rs. The below diagram shows an indifference map with three indifference curves. Thus, in this possibility, the effect of equivalent cash subsidy is exactly the same as the effect of food stamp subsidy. The lower the cost of the commodity, the more the budget line expands outwards. That is, at wage rate w0he supplies TL0 amount of labour. Thus the cost of giving subsidies to consumers is always greater than the money equivalent of the subjective gain to the consumers. An indifference curve is a graphical representation of a combined products that gives similar kind of satisfaction to a consumer thereby making them indifferent.Every point on the indifference curve shows that an individual or a consumer is indifferent between the two products as it gives him the same kind of utility. 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. 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. The excise duty, sales tax are the examples of indirect tax. 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. Property I. Indifference curves slope downward to the right: This property implies that an indifference curve has a negative slope. 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. 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. If you enjoy both pizza and pasta, for example, you might not care whether you purchase 20 pizzas and no pasta . an indifference curve helps the consumer to determine . The loss of satisfaction to the consumer on account of the downward movement must be made up by the gain through the rightward movement. It is worth noting that the movement from Q3 on indifference curve IC3 to Q1 on indifference curve IC1 is the combined result of the income effect and substitution effect caused by the excise duty. 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. 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. Let us consider commodities B1 and B2. He is also satisfied with 2 units of cloth and 4 units of books. 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. MRS between income and leisure equals the wage rate (w) that is, the market exchange rate between the two. 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. Nguyen Quoc Trung. IC2 is the higher indifference curve than IC1. 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). An indifferent curve is drawn from the indifference schedule of the consumer. Without this type of analysis, economists would be unable to predict certain behaviors . Here, we understand that all three products resting in the indifferent curve give him the same satisfaction. In Figure 6, consider the indifference curves I 1 and I 2 and combination N and A respectively on them. This implies that at higher wage rates, labour supply may be reduced in response to further rise in wage rates. it helps to compare the satisfaction of different goods/commodities and enables the consumer to attain the equilibrium. However, as seen above, in practice it is difficult to make a plan that will increase the consumption of subsidised food and will not affect the consumption of other goods. 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. 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. 10 per kg. 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. Thus, TL1 number of work-hours supplied is shown against w1 in panel (b) of Figure 11.18. Choice of other points on income-leisure line MT will show different amounts of leisure, income and work. Other uncategorized cookies are those that are being analyzed and have not been classified into a category as yet. Leisure time can be used for resting, sleeping, playing, listening to music on radios and television etc. Therefore, RM is also greater than PE. 11.20. Therefore, we can draw indifference curves between income and leisure both of which give satisfaction to the individual. Consumers can rank a combination of commodities based on their satisfaction levels. For instance, if price of food is Rs. The indifference curve indicates the various combinations of two goods that yield equal satisfaction to the consumer. 8.8 two perfect complements are consumed in the ratio, 3X: 27. Content Guidelines 2. Microeconomics is a bottom-up approach where patterns from everyday life are pieced together to correlate demand and supply. These cookies track visitors across websites and collect information to provide customized ads. Combination Q has been taken on a higher indifference curve IC2 and combination S on a lower indifference curve IC1. Image Guidelines 5. Some of the important problems are explained below with the help of this technique. With the imposition of excise duty, the price of good X will rise. 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. 11.4 . 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. Cookies help us provide, protect and improve our products and services. The greater the amount of this sacrifice of leisure, that is, the greater the amount of work done, the greater income an individual earns. Whereas income effect of the rise in wage rate tends to reduce supply of labour, substitution effect tends to increase it. 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. 8.6. But the above principle regarding the programme of subsidised food, subsidised housing etc. With equivalent food stamp subsidy of B1C the individual has to choose a point which must be on the kinked budget line B1CL2. . 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. 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. This cookie is set by GDPR Cookie Consent plugin. Likewise, the combinations B and C will give equal satisfaction to the consumer; both being on the same indifference curve IC1. The indifference curve I1 is the locus of the points L, M, N, P, Q, and R, showing the combinations of the two goods X and Y between which the consumer is indifferent. 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. 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. Consumers would prefer to move in the direction indicated by the arrow in the figure. 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. Second, wage rate is the same irrespective of the number of hours he chooses to work. To do so we take away so much income from the individual that he comes back to the original indifference curve IC1. Meaning of Indifference Curve 2. 11.3 where along the X-axis we measure quantity of food and along the F-axis we measure money which represents all other goods, (i.e. Indifference curves between income and leisure are therefore also called trade-off curves. While leisure yields satisfaction to the individual directly, income represents general purchasing power capable of being used to buy goods and services for satisfaction of various wants. In Figure 11.9 with a given income and prices of the two goods X and Y the consumer is in equilibrium at E buying OM of commodity X and ON of commodity Y. In case of perfect substitutes, the indifference curves are parallel straight lines because the consumer equally prefers the two goods and is willing to exchange one good for the other at a constant rate. Consumer goods are the products purchased by the buyers for consumption and not for resale. This means that up to a point substitution effect is stronger than income effect so that labour supply curve slopes upward, but beyond that at higher wage rates supply curve of labour bends backward. It will be seen from Figure 11.1 that PE is less than RM which is the amount of money paid by the Government as subsidy. It's essentially the cost of the next best alternative that has been forgiven.read more play a crucial role in the curve analysis. It will be seen from Figure 11.9 that ration amounts of Rx and Ry of goods X and Y respectively are greater than OM and ON which the consumer is buying with his price-income situation. Anything and everything about Economics their satisfaction levels market exchange rate between the two consider indifference. Be on the assumptions as discussed above combinations of two goods that yield satisfaction. The lower the cost importance of indifference curve with diagram giving subsidies to consumers is always greater than the equivalent! 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