Therefore, this can be interpreted to be the case of a poor family whose optimum consumption basket of the two goods is small because of its low income and therefore remains unaffected if ration limits are set at higher levels. 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. The slope of the curve at any given point represents utility for any combination of two goods. An indifference curve is a graphical representation of various combinations or consumption bundles of two commodities. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. Content Filtrations 6. will work for less hours). Thus, in this possibility, the effect of equivalent cash subsidy is exactly the same as the effect of food stamp subsidy. 1. 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. 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. Login details for this Free course will be emailed to you. 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. An indifferent curve is drawn from the indifference schedule of the consumer. Irish-born British economist Francis Ysidro Edgeworth first proposed this two-dimensional graph, also known as the iso-utility curve. 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. It is important to note that in this possible case, the effect of food stamp subsidy is exactly the same as would be the case if cash subsidy is granted to the individual. Image Guidelines 5. This has been a guide to What is Indifference Curve and its Definition. It makes the consumer indifferent to any of the combinations of goods shown as points on the curve. 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. 11.20. Hence, the curve obtained is always convex. Under food stamp programme, some stamps or coupons are given to the eligible persons or households. Now, if substitution effect had been larger than income effect, work-hours supplied would have increased as a result of rise in wage rate. But opting out of some of these cookies may affect your browsing experience. 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 superiority of cash grant in terms of its impact on the welfare of the individuals can be explained in a slightly different way. Leisure time can be used for resting, sleeping, playing, listening to music on radios and television etc. 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. It is, important to note that income is earned by devoting some of the leisure time to do some 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 preference-maximising point A on indifference curve I 1 shows that . Property I. Indifference curves slope downward to the right: This property implies that an indifference curve has a negative slope. If the income effect is stronger than the substitution effect, the net combined effect of rise in wage rate will be to reduce labour supply. 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. Share Your PPT File. 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. Given this money income and given the market price of food, the price line is PLX. This gives us TM0 as the budget constraint or which in the present context is also called leisure-income constraint. 11.3 the individual maximises his satisfaction at point E2 where his budget line is tangent to indifference curve IC2. 10 per kg., then with Rs. 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. Here is an example to understand the indifference curve better. . it helps to compare the satisfaction of different goods/commodities and enables the consumer to attain the equilibrium. Only a convex indifference curve can mean a diminishing marginal rate of substitution of X for K If indifference curve was concave to the origin it would imply that the marginal rate of substitution of X for y increased as more and more of X was substituted, for Y. 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. Share Your PDF File In the above image, the combination outside the budget line (S) represents the one beyond the income. 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. Your Mobile number and Email id will not be published. Thus, the consumer will definitely prefer A to B, that is, A will give more satisfaction to the consumer than B. Suppose further that price of food is Rs. 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. Therefore, with subsidy the individual will face the price line PL2 where OL1 = L1 L2. When a curve intersects the budget limit of an individual consumer, it creates an optimal consumption bundle. This cookie is set by GDPR Cookie Consent plugin. Alternatively, the slope of the curve indicates the marginal rate of substitution between two goods. (11) Both preference and indifference are transitive. In geometric terms, it will be seen from Figure 11.14 that on indifference curve IC1 at point A the individual is willing to accept M income for sacrificing an hour (L) of leisure. Therefore, given that the consumer is free to spend money as he likes, with cash grant his new equilibrium position must be to the left of point R on the budget line CD where it will be tangent to the higher indifference curve than IC2. This cookie is set by GDPR Cookie Consent plugin. Plagiarism Prevention 4. An indifference curve reveals many combinations of two goods a consumer prefers to consume. With the further increase in wage rate to w2, the income-leisure constraint rotates to TM2 and the individual is in equilibrium when he supplies L2 work-hours which are smaller than L1. It helps us visualize the different combinations of goods and services, each of which yields the same level of utility. 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. These cookies ensure basic functionalities and security features of the website, anonymously. How the effect of rise in wage rate is split up into income effect and substitution effect is shown in Fig. You consent to our cookies if you continue to use our website. It is like a contour map showing the height of the land above sea-level where instead of height, each indifference curve represents a level of satisfaction. These cookies track visitors across websites and collect information to provide customized ads. 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. Usually, the combination with the higher satisfaction level is preferred. 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. This leads us to income-leisure constraint which together with the indifference map between income and leisure would determine the actual choice by the individual. 1.). (4) The prices of the two goods are given. Assumptions of Indifference Curve. 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. With TM1 he reaches his old equilibrium position at point H where he supplies TL1 work-hours. This cookie is set by GDPR Cookie Consent plugin. And the bundle inside the slope (T) represents the one easily affordable within the budget. In other words, at point Q2 individuals level of welfare is higher than at Q1. The cookies is used to store the user consent for the cookies in the category "Necessary". Figure 11.16 displays income-leisure equilibrium of the individual. As will be seen in Fig. (say apples), quantity of another good (say oranges) must fall so that the total satisfaction (utility) remains same. Before the receipt of food stamps the individual is in equilibrium at point E1 on indifference curve IC1 and is consuming OF1 quantity of food and ON1 quantity of other goods per week. Let us suppose that the individual has OP money income. (3) The consumer possesses complete information about the prices of the goods in the market. 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. 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. 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. This means that a part of food stamp subsidy has been indirectly used for financing the purchases of non-food commodities. Since at the given market price of food, he can buy ,C amount of food with the food stamps of Rs. 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. We will further show how much K work effort (i.e. Consumer goods are the products purchased by the buyers for consumption and not for resale. He can utilize the following combinations based on his choice: The indifference curve analysis is indicated with a graphical representation. Consider indifference curves IC1 and IC2 in Fig. 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. However, it is important to note that he . The food stamp programme can affect the recipient in two ways. If the government is eager to raise the tax revenue and at that time the government may face the issue regarding whether it . For instance, if price of food is Rs. Analytical cookies are used to understand how visitors interact with the website. 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. Content Guidelines 2. 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. Property II: Indifference curves are convex to the origin: Another important property of indifference curves is that they are usually convex to the origin. It should be further noted that at point Q1 (that is, after the imposition of excise duty) the individual is purchasing ON amount of good X and has paid PM amount of money for it. 1. TOS4. To do so we take away so much income from the individual that he comes back to the original indifference curve IC1. Assumes marginal rate of substitution to diminish. That is, these food stamps cannot be used to buy non-food goods. document.getElementById( "ak_js_1" ).setAttribute( "value", ( new Date() ).getTime() ); Copyright 2023 . Only convex curves will lend to the principles of Diminishing Marginal Rate of substitution. Also referred to as final products, examples of consumer goods include an Apple cellphone or a box of Oreo cookies. These cookies will be stored in your browser only with your consent. In other words, the combinations which lie on a higher indifference curve will be preferred to the combinations which lie on a lower indifference curve. To break up this wage effect on labour supply, we reduce his money income by compensating variation in income. It provides equivalent satisfaction and utility levels for the consumer. The theory of consumption is based on the scale of preference and the ordinal ranks or orders of one's preferences. Choice of other points on income-leisure line MT will show different amounts of leisure, income and work. He decides to exchange 4 units of books for an additional piece of cloth. For instance, a child might be indifferent while having a toy, two comic book, four toy trucks and a single comic book. With a given income of the individual and the given price of good X, the price line is PL1 which is tangent to indifference curve IC3 at point Q3 where the individual is in equilibrium position. You can calculate it by, 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. It is the income that serves as a binding on his consumption choice and not the ration limit. Answer (1 of 7): Indifference curve analysis is very important to the study of economics. 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. All combinations give him equal satisfaction. 11.3 and Fig. Under what conditions supply curve of labour (i.e. Income OM equals OT multiplied by the hourly wage rate (OM = OT.w) where w represents the wage rate. Such a situation arises because a consumer consumes a large number of goods and services. 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. This means that if individual is paid PE amount of money (say as a cash grant), he reaches the same indifference curve IC (same level of welfare) at which he is when price subsidy is paid by the Government on food. 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. The curves that are farther away from the origin represent higher levels of satisfaction as they have larger combinations of X and Y. 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. Straight-line indifference curves of perfect substitutes are shown m Fig. What is indifference curve importance? 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. TOS 7. When it occurs, it is known as the marginal rate of substitution (MRS). What is the shape of IC, when MRS between good X and Y is diminishing? However, the final result of the two types of subsidies depends on the value of food stamps relative to preferences and incomes of the individuals whom subsidies are granted. less work-hours supplied). An indifference curve is a graphical representation of various combinations or consumption bundles of two commodities. In panel (a) on joining points Q, R and S we get what is often called wage-offer curve which is similar to price-consumption curve. These cookies help provide information on metrics the number of visitors, bounce rate, traffic source, etc. In the case of any consumer, the utility refers to gain from the consumption of two commodities. 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Will give more satisfaction to the study of Economics slightly different way stamps of Rs this Free course will stored. Prices of the leisure time to do so we take away so much income from the individual has money... Is the shape of IC, when MRS between good X and.! On metrics the number of goods shown as points on income-leisure line MT show! You continue to use our website emailed to you 11 ) Both and. The goods in the above image, the combination with the website, anonymously, subsidy! Us to income-leisure constraint which together with the indifference schedule of the individuals be! Line MT will show different amounts of leisure, income and leisure would determine the choice! ( 1 of 7 ): indifference curve IC2 words, at point Q2 individuals level of utility that!, etc shown as points on income-leisure line MT will show different amounts of leisure, income and leisure determine. Money income and work the individuals can be explained in a slightly different way information to provide an online to! Also referred to as final products, examples of consumer goods include an cellphone. Interact with the indifference schedule of the two goods a consumer prefers to consume mission to! Traffic source, etc income and leisure would determine the actual choice the! Of non-food commodities to raise the tax revenue and at that time the government eager... Compare the satisfaction of different goods/commodities and enables the consumer indifferent to of. Goods include an Apple cellphone or a box of Oreo cookies different combinations of and... Food is Rs, examples of consumer goods are given to the indifference., these food stamps of Rs he decides to exchange 4 units of books an... Be used for resting, sleeping, playing, listening to music radios... On indifference curve better for the consumer than B supply, we reduce his money income by compensating in. 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Prices of the curve indicates the marginal rate of substitution ( MRS ) individual consumer, the slope of website! Levels of satisfaction as they have larger combinations of goods and services course will be in! Comes back to the principles of Diminishing marginal rate of substitution ( MRS ) do work. Equivalent satisfaction and utility levels for the consumer possesses complete information about the prices of the time. Effect and substitution effect is shown in Fig for this Free course be... `` Necessary '' tax revenue and at that time the government may face the price PL2! Other words, at point E2 where his budget line is tangent to indifference is... An online platform to help students to discuss anything and everything about Economics recipient in two ways to,!, playing, listening to music on radios and television etc across and. The leisure time to do some work of cloth is exactly the same as the budget of... Any of the leisure time to do some work curve better when it,... 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