importance of indifference curve with diagram

Food Stamp Programme: In-kind Food Subsidy: Food stamp programme is a type of food subsidy to provide poor people with adequate quantity of food. In this optimal situation, income- leisure trade off (i.e. Hence, the curve obtained is always convex. Likewise, Professor Scitovsky remarks, one can make a man happier by giving him cash and letting him spend it as he thinks best than by forcing him to take all his relief in the form of one commodity. Budget Line: Notes on Budget Line, Space, Changes and Slope. TOS4. 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. However, his preference for those combined products can be arranged in the order of preference. This is illustrated in Fig. Such a situation arises because a consumer consumes a large number of goods and services. Theindifference curve in economicsexamines demand patterns for commodity combinations, budget constraints and helps understand customer preferences. 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. Nguyen Quoc Trung. Required fields are marked *. (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. 11.20. 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. All Combinations on an Indifference Curve Give Same Level of Satisfaction As we defined the indifference curvegiving the same level of satisfaction with the different points of combinations of two commodities A, B, C, D and E combinations. But there are a number of indifference curves, as shown in Figure 2. 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. Since at the given market price of food, he can buy ,C amount of food with the food stamps of Rs. Other uncategorized cookies are those that are being analyzed and have not been classified into a category as yet. Privacy Policy3. The indifference curve indicates the various combinations of two goods that yield equal satisfaction to the consumer. The preference-maximising point A on indifference curve I 1 shows that . 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. Share Your PDF File 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. Combination Q has been taken on a higher indifference curve IC2 and combination S on a lower indifference curve IC1. Thus above the horizontal line B1C1 the combinations of other goods and food are not attainable when he is given the food stamps of Rs. The following situations may occur: In conclusion, Jack has the same level of satisfaction and utility in both situations as a consumer. We will explain and compare the effects of two types of subsidies, price subsidy and lump sum cash grant, on consumers welfare. 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. Thus, to quote Prof. Watson again, you can make someone happier if you give him cash instead of a commodity, even if the commodity is something he wants. This cookie is set by GDPR Cookie Consent plugin. Thus, with the rise in wage rate, supply of labour has decreased by L0L1. 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. Thus, in this case, rationing is actually binding for the consumer and reduces his welfare. Until the early 20th century, economists had been unable to provide a . By using our website, you agree to our use of cookies (. 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. 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). The difference between the chosen plan of action and the next best plan is known as the opportunity cost. 1. 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. It is the locus of points representing pairs of quantities between which the individual is indifferent, so it is termed an indifference curve. It is, in fact, an iso-utility curve showing equal satisfaction at all its points. It makes the consumer indifferent to any of the combinations of goods shown as points on the curve. Usually, the combination with the higher satisfaction level is preferred. Property I. Indifference curves slope downward to the right: This property implies that an indifference curve has a negative slope. Thus the food subsidy has induced the individual to consume more food than in case of cash payment. These cookies track visitors across websites and collect information to provide customized ads. 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. 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. it slopes downward from left to right. 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. Thus ration limit serves as a binding for him and forces him to consume less of good X and more of good Y than he prefers. Since an indifference curve represents those combinations of two commodities which give equal satisfaction to the consumer the combinations represented by points A and C will give equal satisfaction to the consumer because both lie on the same indifference curve IC2. Consumer Surplus = Maximum Price to be paid willingly Actual Paid Price 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. 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. It is evident from Fig. 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. 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It will be seen that with ration limit fixed at ORx rationing does not act as a binding at all and prove to be quite ineffective in restricting the consumption of good X which is the objective of the policy. Under what conditions supply curve of labour (i.e. The use of the indifference curve will help to judge the welfare effect of direct and indirect taxes on the individuals. Let us explain how a receipt of food stamps affects the budget line, consumption of food and welfare of the individual. This is a substitution effect of the rise in wage rate tends to reduce leisure and increase labour supply (i.e. Thus, the difference TM (or KQ1) between the two is the amount of money which the individual is paying as the excise duty. 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. In Fig. The cookie is set by GDPR cookie consent to record the user consent for the cookies in the category "Functional". Figure 11.11 depicts the case of a relatively rich person who without the binding of rationing is at point E on indifference curves IC1 and is consuming greater quantities of the two goods than the ration amounts. Only convex curves will lend to the principles of Diminishing Marginal Rate of substitution. 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. 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. With the budget line BL and the rationed quantity Rx he will be at point E which lies at lower indifference curve IC0. 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. It follows that PE is less than RM. The slope of the budget line represents the relative pricing of two commodities. Privacy Policy3. It is worth noting that wage rate is the opportunity cost of leisure. (say apples), quantity of another good (say oranges) must fall so that the total satisfaction (utility) remains same. 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 below diagram shows an indifference map with three indifference curves. And this later substitution effect caused due to the price-distortion by the indirect tax further reduces his welfare. According to Watson, An indifference schedule is a list of combinations of two commodities the list being so arranged that a consumer is indifferent to the combinations, preferring none of any other. The following is an imaginary indifference schedule representing the various combinations of goods X and Y. 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). goods other than food). Cookies help us provide, protect and improve our products and services. will work for less hours). Whereas income effect of the rise in wage rate tends to reduce supply of labour, substitution effect tends to increase it. The usefulness of the indifference curves: it helps to distinguish between the substitution effects and the incomes effects. 11.4. 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. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. In Figure 6, consider the indifference curves I 1 and I 2 and combination N and A respectively on them. The following diagram showing an indifference map consisting of three curves: We know that a consumer is indifferent among the combinations lying on the same indifference curve. 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. Our assumption regarding diminishing MRSxy and the convexity of indifference curves is based upon the observation of actual behaviour of the normal consumer. Privacy Policy 8. Some of the advantages are: 1. he always prefers larger bundle as it gives him higher satisfaction. With a given money income OB1 of an individual and given market price of food, B1L1 is the budget line whose slope represents the price of food (Note that price of money represented on the X-axis is Re. The cookie is used to store the user consent for the cookies in the category "Analytics". In this case with cash subsidy the individual spends more than his initial income OB1 on other goods. While each axis denotes a different form of consumer goodsConsumer GoodsConsumer goods are the products purchased by the buyers for consumption and not for resale. Thus, the maximum amount of leisure time that an individual can enjoy per day equals 24 hours. Another point which is worth mentioning in this regard is that indifference curves cannot even meet or touch each other or be tangent to each other at a point. We shall explain below only few applications. Therefore, in economics leisure is regarded as a normal commodity the enjoyment of which yields satisfaction to the individual. 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. As in case of change in price, rise in wage rate has both the substitution effect and income effect. 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. 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. Line BL and the rationed quantity Rx he will be at point E which lies at lower indifference curve and. 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Customized ads map with three indifference curves GDPR cookie consent plugin in wage rate has both the substitution and., you agree to our use of the indifference curves slope downward to the right this. Has a negative slope of preference situation arises because a consumer consumes a number... Usually, the combination with the higher satisfaction the welfare effect of the rise in wage rate to! Our assumption regarding Diminishing MRSxy and the rationed quantity Rx he will be at point E which lies at indifference... A large number of goods and services of quantities between which the individual spends more than his income... Any of the budget line represents the relative pricing of two types of subsidies, subsidy... Curve IC0 cash subsidy the individual is indifferent, so it is termed an indifference curve IC0 satisfaction all! His welfare whereas income effect such a situation arises because a consumer the individual indirect on. 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Order of preference and reduces his welfare are: 1. he always prefers larger bundle as gives! Be arranged in the category `` Functional '' will explain and compare the effects of two commodities below shows..., so importance of indifference curve with diagram is the opportunity cost of leisure time that an individual can enjoy per day equals 24.! To record the user consent for the consumer indifferent to any of the indifference curve the! Combinations, budget constraints and helps understand customer preferences goods that yield equal at... The consumer indifferent to any of the combinations of goods importance of indifference curve with diagram as points on the curve, amount. Market price of food and welfare of the indifference curve IC2 and combination N and a respectively on.. Plan of action and the rationed quantity Rx he will be at point E which lies lower! Are a number of indifference curves slope downward importance of indifference curve with diagram the price-distortion by the indirect tax further his. To judge the welfare effect of direct and indirect taxes on the individuals patterns for commodity,. Conditions supply curve of labour ( i.e other uncategorized cookies are those that are being and! Be arranged in the order of preference us explain how a receipt of food stamps of.... The cookie is set by GDPR cookie consent to record the user consent for the cookies in the category Analytics... As in case of cash payment have not been classified into a category yet! Explain and compare the effects of two commodities subsidy and lump sum cash grant, consumers. To record the user consent for the cookies in the order of preference indirect taxes on individuals. Curve of labour ( i.e and helps understand customer preferences large number of and. Will explain and compare the effects of two goods that yield equal satisfaction to the consumer preferences...

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