You may also have a look at the following articles to learn more , Your email address will not be published. You consent to our cookies if you continue to use our website. Here is an example to understand the indifference curve better. 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. It Provides a . The marginal rate of substitution (MRS) indicates if a consumer is willing to sacrifice one good for another commodity while maintaining the same level of utility. The following situations may occur: In conclusion, Jack has the same level of satisfaction and utility in both situations as a consumer. 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. We know that consumers in actual world do not generally buy and consume one good. 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. Pen and ink, right shoe and left shoe, automobile and petrol sauce and hamburger, type writer and typists are some examples of perfect complements. Without this type of analysis, economists would be unable to predict certain behaviors . It allows the consumer to buy within a given budget, i.e., within their current income. 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. 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. An indifferent curve is drawn from the indifference schedule of the consumer. (12) The consumer is in a position to order all possible combinations of the two goods. Let us consider commodities B1 and B2. But given the preferences of the individual between food and other goods, he is in equilibrium at the same point E2 at which his budget line B2L2 is target to the indifference curve IC2. If the government is eager to raise the tax revenue and at that time the government may face the issue regarding whether it . document.getElementById( "ak_js_1" ).setAttribute( "value", ( new Date() ).getTime() ); Copyright 2023 . 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. It provides equivalent satisfaction and utility levels for the consumer. What is indifference curve importance? 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. The slope of the curve at any given point represents utility for any combination of two goods. Consumers would prefer to move in the direction indicated by the arrow in the figure. An indifference map between income and leisure is depicted in Figure 11.14 and has all the usual properties of indifference curves. 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. The cookie is used to store the user consent for the cookies in the category "Performance". (10) The consumer arranges the two goods in a scale of preference which means that he has both preference and indifference for the goods. By purchasing OA quantity of food, the individual is spending PT amount of money. IC2 is the higher indifference curve than IC1. The indifference curve analysis work on a simple graph having two-dimensional. Of course, these ration limits narrow down or truncate his market opportunity set at both ends on the X and Y axes, and in this way they are potentially binding but they are not effective in restraining his consumption. 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. In other words, besides analysing consumers demand, indifference curves have several other applications. 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). An indifference curve is a downward sloping convex line connecting the quantity of one good consumed with the amount of another good consumed. For instance, the aim of Governments food subsidy programme may be that the needy families should consume more food so that their health and efficiency may be improved. 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. 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. 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. it provides an ordinal measurement of utility. (6) He prefers more of X to less of Y or more of Y to less of X. 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. 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. These combinations provide the same level of satisfaction and utility to the consumer. It does not store any personal data. 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. Whereas income effect of the rise in wage rate tends to reduce supply of labour, substitution effect tends to increase it. It is worth noting that wage rate is the opportunity cost of leisure. Though the consumer can buy the ration amount, that is, ration limit is attainable but he is not willing to consume good X as much as the ration limit permits him. Consumer goods companies and the industry offer a vast range of products that heavily contribute to the global economy. 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. One possibility is that with the food-stamp subsidy and resultant kinked budget line B1CL2, in Fig. Straight-line indifference curves of perfect substitutes are shown m Fig. How the effect of rise in wage rate is split up into income effect and substitution effect is shown in Fig. Direct taxes are those taxes whose incidence cannot be shifted to others. 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 . The consumer is rational to maximize the satisfaction and makes a transitive or consistent choice. As one moves along a straight-line indifference curve of perfect substitutes, marginal rate of substitution of one good for another remains constant. AB is such line obtained after reducing his money income by compensating variation. With equivalent food stamp subsidy of B1C the individual has to choose a point which must be on the kinked budget line B1CL2. This supply of labour is directly shown against wage rate w0 in panel (b) of Figure 11.18. This is an important feature of Indifference Curve. goods other than food). In this figure we measure money income on the Y-axis and leisure (reading from left to right) and labour supply (reading from right to left) on the X-axis. 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. The derivation of supply curve of labour is depicted in 11.18. Therefore, in economics leisure is regarded as a normal commodity the enjoyment of which yields satisfaction to the individual. 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. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. 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. (5) The consumers tastes, habits and income remain the same throughout the analysis. 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. TOS 7. The indifference curve analysis work on a simple graph having two-dimensional. Other uncategorized cookies are those that are being analyzed and have not been classified into a category as yet. In other words, up to wage rate w0 labour supply curve slopes upward and beyond that it starts bending backward. 11.3 and Fig. 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. Your email address will not be published. This is illustrated in Fig. Combination L contains more of both goods X and Y than combination M on IC1. In this equilibrium position the individual works for TL1 hours per day (TL1 = OT-OL1). Consider Figure 11.5 where on the X-axis, good X and on the F-axis money is measured. an indifference curve helps the consumer to determine . The farther the Indifference curve from the origin, then: 2. Since all consumption bundles give an equal amount of utility, the consumer is indifferent to all combinations. When a consumer wants to have more of a commodity, he/she will have to give up some of the other commodity, given that the consumer remains on the same level of utility at constant income. Alternatively, the slope of the curve indicates the marginal rate of substitution between two goods. Let us take the case of food subsidy which is given by the Government to help the needy families. With these stamps, the recipient can buy food and only food. Property I. Indifference curves slope downward to the right: This property implies that an indifference curve has a negative slope. 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. The use of the indifference curve will help to judge the welfare effect of direct and indirect taxes on the individuals. In Figure 11.11 both ration limits Rx and Ry are actually binding and force the individual to consume less of both the commodities than he consumes at his equilibrium position E in the absence of rationing of the two commodities. The cookie is used to store the user consent for the cookies in the category "Other. (7) An indifference curve is negatively inclined sloping downward. We also use third-party cookies that help us analyze and understand how you use this website. It will be seen from Figure 11.16 that the given income-leisure line MT is tangent to the indifference curve IC2 at point E showing choice of OL1 of leisure and OM1 of income. To do overtime work, he will have to sacrifice more leisure-time and therefore to provide him incentive to forego more leisure and thus to work for more hours it is required to pay him higher wage rate. 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. It follows that PE is less than RM. That is, these food stamps cannot be used to buy non-food goods. This cookie is set by GDPR Cookie Consent plugin. Consumer Surplus = Maximum Price to be paid willingly Actual Paid Price Thus, the consumer will definitely prefer A to B, that is, A will give more satisfaction to the consumer than B. , habits and income remain the same level of satisfaction and makes a transitive or consistent choice in economics is... Indifferent to all combinations the global economy how the effect of direct and indirect taxes on the X-axis, X! 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About economics consent for the cookies in the Figure demand, indifference curves is drawn the... Use third-party cookies that help us analyze and understand how you use this website the Figure Figure 11.5 importance of indifference curve with diagram! Is an example to understand the indifference curve is drawn from the curve... Continue to use our website convex line connecting the quantity of one good for another remains.. Curve of perfect substitutes, marginal rate of substitution of one good another! Choose a point which must be on the kinked budget line B1CL2, in.! Then: 2 do not generally buy and consume one good for another remains constant direct and taxes... Our website direct and indirect taxes on the kinked budget line B1CL2, in leisure! Quantity of one good may occur: in conclusion, Jack has the level... His money income by compensating variation and has all the usual properties of curves! 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