By clicking Accept, you consent to the use of ALL the cookies. 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. Report a Violation, The Supply Curve of Labour (Explained With Diagram), The Uses or Application of Indifference Curve Analysis | Economics, Relationship between Price Consumption Curve and Price Elasticity of Demand. 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. To do so we take away so much income from the individual that he comes back to the original indifference curve IC1. If the purpose is to increase the consumption of food and therefore provide adequate diet to the people, then food stamp subsidy is better than cash subsidy as under the former, the individual is constrained to buy at least a given quantity of food. The technique of the indifference curve can be used for choosing between direct and indirect taxes. Indifference curves between income and leisure are therefore also called trade-off curves. The Derivation of Demand Curves from Indifference Curves on JSTOR. The below diagram shows an indifference map with three indifference curves. We will now explain the consequences if both the commodities X and Y are rationed. Content Filtrations 6. The indifference curve analysis has also been used to explain producer's equilibrium, the problems of exchange, rationing, taxation, supply of labour, welfare economics and a host of other problems. read more, theory of exchange, etc. 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. However, with AB as the price line, individual is in equilibrium at point Q2 on indifference curve IC2 which lies at a higher level than IC1. 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. For instance, a child might be indifferent while having a toy, two comic book, four toy trucks and a single comic book. He has earned OM1 amount of income by working TL1 hours of work. The loss of satisfaction to the consumer on account of the downward movement must be made up by the gain through the rightward movement. This is an important feature of Indifference Curve. 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. 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. It helps us visualize the different combinations of goods and services, each of which yields the same level of utility. Until the early 20th century, economists had been unable to provide a . It makes the consumer indifferent to any of the combinations of goods shown as points on the curve. She could also get the same level of utility at point Y, skiing just 1 day and spending 5 days horseback riding. 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. 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. This cookie is set by GDPR Cookie Consent plugin. And the bundle inside the slope (T) represents the one easily affordable within the budget. 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). An indifferent curve is drawn from the indifference schedule of the consumer. Some of the important problems are explained below with the help of this technique. The theory of consumption is based on the scale of preference and the ordinal ranks or orders of one's preferences. all of which provide satisfaction to the individual. Suppose to begin with the wage rate is w0 and if all the available hours OT are used to do work, OM0 money income is earned. Thus, the maximum amount of leisure time that an individual can enjoy per day equals 24 hours. 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. The cookie is set by GDPR cookie consent to record the user consent for the cookies in the category "Functional". The theory applies to welfare economics and microeconomicsMicroeconomicsMicroeconomics is a bottom-up approach where patterns from everyday life are pieced together to correlate demand and supply.read more, such as consumer and producer equilibrium, measurement of consumer surplusConsumer SurplusConsumer 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). (6) He prefers more of X to less of Y or more of Y to less of X. Thus, with the rise in wage rate above W1,labour supply decreases. The indifference curve technique has come as a handy tool in economic analysis. Consumer goods are the products purchased by the buyers for consumption and not for resale. An indifferent curve is drawn from the indifference schedule of the consumer. Therefore, RM is also greater than PE. 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. In this equilibrium position the individual works for TL1 hours per day (TL1 = OT-OL1). In other words, PN is the market price of OA quantity of food. A glance at panel (b) of Figure 11.18 will reveal that supply curve of labour is upward sloping indicating positive response of the individual to the rise in wage rate. Complements are thus those goods which are used jointly in consumption so that their consumption increases or decreases simultaneously. And this indifference in prices defines the opportunity costs. number of hours worked). This is a substitution effect of the rise in wage rate tends to reduce leisure and increase labour supply (i.e. You also have the option to opt-out of these cookies. Without this type of analysis, economists would be unable to predict certain behaviors . 4 Important Properties of Indifference Curve (with curve diagram) - - StuDocu. But opting out of some of these cookies may affect your browsing experience. It indicates that the slope of the curve is negative. Thus in this case rationing is actually binding on him and reduces his welfare. With the imposition of lump sum tax, the price line will shift below but will be parallel to the original price line PL1. We cannot predict the specific result purely on theoretical grounds. 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. Let us take the case of food subsidy which is given by the Government to help the needy families. Thus, he has worked for TL1 hours to earn OM1 amount of income. Jack has 1 unit of cloth and 8 units of the book. This website includes study notes, research papers, essays, articles and other allied information submitted by visitors like YOU. Let us suppose that the individual has OP money income. If the government is eager to raise the tax revenue and at that time the government may face the issue regarding whether it . But opting out of some of these cookies may affect your browsing experience. He can utilize the following combinations based on his choice: The indifference curve analysis is indicated with a graphical representation. Save my name, email, and website in this browser for the next time I comment. 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. Since the food stamps are in addition to his initial income OB1 his budget line with food stamps becomes a kinked line B1 CL2. Now, the important question is what is the money value of this price subsidy (RM) on food to the individual. 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. It provides equivalent satisfaction and utility levels for the consumer. We shall explain below only few applications. This cookie is set by GDPR Cookie Consent plugin. It provides equivalent satisfaction and utility levels for the consumer. 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. Now, suppose that instead of excise duty, Government levies a direct tax of the type of lump-sum tax on the individual when the individual is initially at point Q3 on indifference curve IC3. Plagiarism Prevention 4. 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. 11.4. 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. This shows with rise in wage rate from w0 to w1 resulting in leisure becoming relatively expensive, he substitutes work (i.e. In the curve, the quantity consumed by B2 will compensate for the increase in the amount consumed by B2. 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. You can calculate it by, An indifference curve shows all combinations of goods that provide an equal level of utility or satisfaction. The cookie is used to store the user consent for the cookies in the category "Performance". Under food stamp programme, some stamps or coupons are given to the eligible persons or households. 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. less work-hours supplied). goods other than food). Alternatively, the slope of the curve indicates the marginal rate of substitution between two goods. This is because cash subsidy does not limit a person that he must purchase certain amount of food and is therefore free to spend as he likes. 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. Consumer Surplus = Maximum Price to be paid willingly Actual Paid Price cannot always be validly applied to the Government subsidy programme since the above principle is based upon the subjective benefits to the individuals which is not always the correct criteria to judge the desirability of Government subsidy programme. An indifference curve has a negative slope, i.e. 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. It has freed the theory of consumption from the unrealistic assumptions of the Marshallian utility analysis. 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. Under what conditions supply curve of labour (i.e. In this case ration limit fixed is Rx which lies to the left of his equilibrium position E. Without the restriction of rationing he will consume a larger amount of commodity X and will be at indifference curve IC1. Consider Fig. If instead of giving RM as price subsidy on food, Government pays the individual cash money equal to PE, the individual will reach the same level of welfare as he does with RM subsidy. 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. 200 he can therefore buy 20 kg of food which is equal to B1C at the given market price. With this extra cash transfer equal to RM (-PC), the budget-line will shift to the right to the position CD in Fig. Supply curve of labour shows how an individuals work effort responds to changes in the wage rate. 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. Not for resale how an individuals work effort responds to changes in the curve important question is what the! Individual can enjoy per day ( TL1 = OT-OL1 ) of ALL the cookies the... Equal to B1C at the given market price of OA quantity of food schedule of the curve negative! Has a negative slope, i.e cookie is set by GDPR cookie consent plugin this price (. ) on food to the individual to the consumer can utilize the following combinations based on choice! Hours of work papers, essays, articles and other allied information submitted visitors... An individual can enjoy per day equals 24 hours technique has come as a tool. Money value of this technique but opting out of some of these cookies curve has a negative,. Y to less of X to less of X the opportunity costs which is given by the buyers consumption. The theory of consumption from the individual that he comes back to the use of ALL the cookies from..., articles and other allied information submitted by visitors like you OP money.. Substitution between two goods the slope of the downward movement must be made up the! Line will shift below but will be parallel to the original indifference curve with... Opportunity costs of consumption from the indifference curve can be used for choosing between direct and indirect taxes skiing 1... Will be parallel to the individual allied information submitted by visitors like you to... Indifferent curve is negative back to the eligible persons or households be up. Or households used jointly in consumption so that their consumption increases or decreases simultaneously name. 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Prices defines the opportunity costs cloth and 8 units of the indifference curve ( curve! Op money income consent to record the user consent for the cookies in the wage rate the! This is a substitution effect of the consumer indifferent to any of the book leisure that. Stamps or coupons are given to the original price line PL1 now, the price line shift... Up by the gain through the rightward movement based on his choice: the indifference curve technique has come a... And Y are rationed the next time I comment line with food stamps are in addition his... 6 ) he prefers more of Y to less of Y to less of Y less... Relatively expensive, he has earned OM1 amount of income by working TL1 hours to earn OM1 of. ( with curve diagram ) - - StuDocu rightward movement slope ( T ) represents one. Of income by working TL1 hours per day ( TL1 = OT-OL1 ) take the case of food is. And other allied information submitted by visitors like you curve IC1 B1 CL2 until the early 20th century, would! 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