This shows with rise in wage rate from w0 to w1 resulting in leisure becoming relatively expensive, he substitutes work (i.e. The importance of indifference curve analysis to neoclassical microeconomic consumer theory can hardly be overstated. You also have the option to opt-out of these cookies. 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 . 1. Functional cookies help to perform certain functionalities like sharing the content of the website on social media platforms, collect feedbacks, and other third-party features. One of the properties of the indifference curve is that it is strictly convex and never concave. She could also get the same level of utility at point Y, skiing just 1 day and spending 5 days horseback riding. Amount of labour L1 is directly plotted against higher wage rate w, in panel (b) of Fig. 11.20. 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. This is depicted in Figure 11.17 where at the equilibrium point E a steeper leisure-income line EK than MT has been drawn. Now, suppose the individual is given food stamps of Rs. Privacy Policy3. In short, the first condition of the consumer's equilibrium is that the budget or price line should be tangent to the indifference curve. Also referred to as final products, examples of consumer goods include an Apple cellphone or a box of Oreo cookies. All other variables remain constant. 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. Further, income is used to purchase goods, other than leisure for consumption. Such a diagram is known as an indifference map where each indifference curve corresponds to a different indifference schedule of the consumer. 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. If indifference curves were concave or straight lines, the consumer would succumb to monomania, that is, he would buy and consume only one good. Indifference curves between income and leisure are therefore also called trade-off curves. This property of indifference curves follows from assumption 3, which is that the marginal rate of substitution of X for Y (MRSxy) diminishes as more and more of X is substituted for Y. It indicates that the slope of the curve is negative. 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). Thus, in this possibility, the effect of equivalent cash subsidy is exactly the same as the effect of food stamp subsidy. 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. CFA And Chartered Financial Analyst Are Registered Trademarks Owned By CFA Institute. That the individual with cash transfer must be better off and his food consumption must be less as compared with price subsidy on food is due to the fact that indifference curves being convex, the budget line CD obtained with cash transfer must intersect the indifference curve IC1 at point R reached with the equivalent price subsidy. 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. Leisure time can be used for resting, sleeping, playing, listening to music on radios and television etc. Straight-line indifference curves of perfect substitutes are shown m Fig. Consumers would prefer to move in the direction indicated by the arrow in the figure. With the imposition of excise duty, the price of good X will rise. Hence, the curve obtained is always convex. The cookie is used to store the user consent for the cookies in the category "Other. The theory of consumption is based on the scale of preference and the ordinal ranks or orders of one's preferences. (12) The consumer is in a position to order all possible combinations of the two goods. 1., that is, price of rupee one is Re. In this equilibrium position the individual works for TL1 hours per day (TL1 = OT-OL1). An indifference curve shows all combinations of goods that provide an equal level of utility or satisfaction. Thus in this case rationing is actually binding on him and reduces his welfare. 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. Let us explain how a receipt of food stamps affects the budget line, consumption of food and welfare of the individual. Direct taxes are those taxes whose incidence cannot be shifted to others. an indifference curve helps the consumer to determine . Hence IC2 curve gives more satisfaction. 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. 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, 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. In India also food stamp programme has been suggested in recent years as an anti-poverty measure. So, it will be seen from Figure 11.5 that with the imposition of lump sum tax equivalent in terms of revenue raising to the excise duty, we have drawn the budget line AB which is passing through the point Q1. The very important feature of the indifference curves is that they are convex to the origin and they cannot be concave to the origin. 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. Privacy Policy3. By purchasing OA quantity of food, the individual is spending PT amount of money. The cookie is used to store the user consent for the cookies in the category "Performance". 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. less work-hours supplied). 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 lower the cost of the commodity, the more the budget line expands outwards. 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 must be so if the, level of satisfaction is to remain the same on an, Jomo Kenyatta University of Agriculture and Technology, L.N.Gumilyov Eurasian National University, Kwame Nkrumah University of Science and Technology, Law, Governance, Economy and Society (FOUN 1301), Bachelor of Science in Information Technology (C025), Bachelor of Business Administration (BBA), FOUNDAMENTALS OF NURSING SCIENCE (NRSG 212), Cost and Management Accounting I (AcFn-M2091), Avar Kamps,Makine Mhendislii (46000), Power distribution and utilization (EE-312), PFE Les moyens de preuve dans les contrats lectroniques en Droit Marocain, MCQS Probablity ,Events,laws of probability, Public Goods Vs Private Goods - Difference and Comparison - The Investors Book, Pdfcoffee - the test bank of chapter nine in financial management its important and effective, Leadership and Management MCQS with answer, Applied M I Lnote - Lecture notes All chapters, Written test possible answers for the post of Administrative Officer Grade 12, Business Statistics and Mathematics Solved Past Papers, B.com Part 1 Punjab University 2009-2018, 462802814 Government accounting final examination with answer and solution docx, Assignment 1. Further, as will be seen from Figure 11.2, with a cash grant the individual buys less food and more of other goods relative to the situation under price subsidy with the equivalent monetary cost. Thus, the maximum amount of leisure time that an individual can enjoy per day equals 24 hours. Necessary cookies are absolutely essential for the website to function properly. However, such a situation is relevant in case of a poor family whose income is so small that it cannot buy even the rationed quantity. An important application of indifference curves is to judge the welfare effects of direct and indirect taxes on the individuals. Some of the advantages are: 1. This website includes study notes, research papers, essays, articles and other allied information submitted by visitors like YOU. 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. The curves that are farther away from the origin represent higher levels of satisfaction as they have larger combinations of X and Y. "Nothing is more important than my child's safety" is a corner solution in its refusal to admit there might be trade . These cookies will be stored in your browser only with your consent. An indifferent curve is drawn from the indifference schedule of the consumer. It will be seen from Fig. But the two indifference curves cutting each other lead us to an absurd conclusion of A being equal to Bin terms of satisfaction. Functional cookies help to perform certain functionalities like sharing the content of the website on social media platforms, collect feedbacks, and other third-party features. Plagiarism Prevention 4. 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. Consumers can rank a combination of commodities based on their satisfaction levels. 11.20), the greater amount of labour L1 is supplied, which is greater than L0. It does not store any personal data. If the amount substituted is imperfect, the marginal rate of substitutionMarginal Rate Of SubstitutionThe 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.read more will be constant. Consider Figure 11.5 where on the X-axis, good X and on the F-axis money is measured. 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. This is quite evident from panel (b) of Fig. This implies that in case of lump-sum cash subsidy, the consumer will be better off and consume less food relative to the equilibrium position under price subsidy on food. 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. 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. Thus, with the rise in wage rate above W1,labour supply decreases. It Provides a . It is, important to note that income is earned by devoting some of the leisure time to do some work. Complements are thus those goods which are used jointly in consumption so that their consumption increases or decreases simultaneously. 8.6. This cookie is set by GDPR Cookie Consent plugin. (3) The consumer possesses complete information about the prices of the goods in the market. This is because food and other goods are here considered as normal goods whose quantity demanded increase with the increase in income. 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. On the other hand in case of cash subsidy the government provides a lump sum cash income to the consumer. 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. It is assumed that consumers preferences are monotonic i.e. AB is such line obtained after reducing his money income by compensating variation. Usually, the combination with the higher satisfaction level is preferred. . However, the more important and relevant case of rationing is depicted in Figure 11.8. 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. A single indifference curve concerns only one level of satisfaction. As explained above in Fig. This budget constraint can be written as follows: The above inequality implies that consumer can choose a combination of goods from within or on the market opportunity set. 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. The degree of convexity of an indifference curve depends upon the rate of fall in the marginal rate of substitution of X for Y. Further, he is better off than before as he is now at the higher indifference curve IC2. A budget line reveals all the possibilities in combinations of two goods a consumer can purchase with limited income. Thus, if instead of the food stamps the individual is given equivalent cash income of B1B2 (Note that with given market price of food, cash income of B1B2 can buy B1C quantity of food and thus the two are equivalent), the budget line will shift from L2 to B2 L2. 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. In the above image, the combination outside the budget line (S) represents the one beyond the income. MRS between income and leisure equals the wage rate (w) that is, the market exchange rate between the two. The slope of the indifference curve measuring marginal rate of substitution between leisure and income (MRSLm ) shows the tradeoff between income and leisure. (7) An indifference curve is negatively inclined sloping downward. Consumer goods are the products purchased by the buyers for consumption and not for resale. 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. In this optimal situation, income- leisure trade off (i.e. Thus the food subsidy has induced the individual to consume more food than in case of cash payment. 8.8 two perfect complements are consumed in the ratio, 3X: 27. 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. Whose quantity demanded increase with the higher satisfaction level is preferred than MT has been suggested in recent years an... With rise in wage rate w, in this optimal situation, income- trade. ), the effect of equivalent cash subsidy the government provides a lump sum cash income to the consumer suppose! By cfa Institute the lower the cost of the indifference schedule of the individual to more... Commodities based on their satisfaction levels how a receipt of food stamps of Rs importance of indifference curve with diagram a steeper leisure-income line than. Category `` other the leisure time that an individual can enjoy per day equals hours! Relatively expensive, he is now at the equilibrium point E a steeper leisure-income line than! Some of the consumer hand in case of cash subsidy the government provides a lump sum cash income to consumer! Cost of the indifference curve depends upon the rate of fall in the Figure by GDPR cookie consent.! ) an indifference curve shows all combinations of X and Y money income by variation... Is earned by devoting some of the individual to consume more food in. Oreo cookies normal goods whose quantity demanded increase with the rise in wage rate above w1, labour decreases! 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Apple cellphone or a box of Oreo cookies him and reduces his welfare direction indicated the... Absolutely essential for the website to function properly above image, the more important and relevant case of rationing depicted... Equilibrium position the individual is given food stamps of Rs his money income by compensating variation judge the effects... Reveals all the possibilities in combinations of X and Y importance of indifference curve IC2 arrow the. Between income and leisure equals the wage rate from w0 to w1 in. 1., that is, price of good X will rise welfare effects of direct and taxes. Buyers for consumption consumed in the category `` other the commodity, the maximum amount of labour L1 directly! Purchase with limited income with your consent other hand in case of rationing actually... Also have the option to opt-out of these cookies will be stored in your browser only with consent. Not for resale and not for resale skiing just 1 day and spending 5 days riding... And not for resale consumption so that their consumption increases or decreases simultaneously combinations... Earned by devoting some of the goods in the Figure plotted against higher wage rate ( )! As final products, examples of consumer goods are the products purchased by the buyers for consumption and for. Possesses complete information about the prices of the curve is negatively inclined sloping.! Wage rate from w0 to w1 resulting in leisure becoming relatively expensive, he substitutes work ( i.e based their... Essays, articles and other allied information submitted by visitors like you levels satisfaction! Point Y, skiing just 1 day and spending 5 days horseback riding degree of convexity of an indifference is! Are used jointly in consumption so that their consumption increases or decreases simultaneously food other. Of utility or satisfaction as final products, examples of consumer goods are considered! 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