8.8 the left- hand portion of an indifference curve of the perfect complementary goods is a vertical straight line which indicates that an infinite amount of Y is necessary to substitute one unit of X and the right-hand portion of the indifference curve is a horizontal straight line which means that an infinite amount of X is necessary to substitute one unit of Y. Also, it means the consumer cannot prefer one bundle over another on the same graph. With equivalent food stamp subsidy of B1C the individual has to choose a point which must be on the kinked budget line B1CL2. TOS4. A single indifference curve concerns only one level of satisfaction. number of hours worked). Another important conclusion from this possible case is that with either food stamp subsidy or cash subsidy the individual buys more of both food and other goods than he buys before the grant of subsidy. Now, if substitution effect had been larger than income effect, work-hours supplied would have increased as a result of rise in wage rate. The imposition of a lump-sum tax (or any income tax) does not affect the prices of goods because it is not levied on any saleable goods. Assumes marginal rate of substitution to diminish. In particular, mention may be made of consumer's equilibrium, derivation of the demand curve and the concept of . Let us consider commodities B1 and B2. Choice of other points on income-leisure line MT will show different amounts of leisure, income and work. 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. Consumer Surplus = Maximum Price to be paid willingly Actual Paid Price 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. 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). Jack has 1 unit of cloth and 8 units of the book. It Dispenses with Cardinal Measurement of Utility 2. an indifference curve helps the consumer to determine . 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. We use cookies to personalise content and ads, to provide social media features and to analyse our traffic. A budget line reveals all the possibilities in combinations of two goods a consumer can purchase with limited income. Share Your Word File Indifference curves are heuristic devices used in contemporary microeconomics to demonstrate consumer preference and the limitations of a budget. The effect of this subsidy on consumers welfare and money value of this subsidy to the consumer is illustrated in Figure 11.1 where the quantity of food is measured on the X- axis and money on the Y-axis. In other words, at point Q2 individuals level of welfare is higher than at Q1. 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. 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 indifferent curve is drawn from the indifference schedule of the consumer. 8.8 two perfect complements are consumed in the ratio, 3X: 27. In our Figure PE = MK (the vertical distance between two parallel lines) and RM is greater than MK. Each individual axis indicates a single type of economic goods. This means that a part of food stamp subsidy has been indirectly used for financing the purchases of non-food commodities. The farther the Indifference curve from the origin, then: 2. 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. With the budget line B1CL2 with food stamp subsidy of B1C, the best that the individual can do is to choose the corner point C of budget line B1CL2 which lies on the highest possible indifference curve IC2 which passes through the point C. Therefore, from the point of individual welfare we reach our earlier conclusion that cash subsidy is superior to in-kind subsidy represented by food stamps programme. Save my name, email, and website in this browser for the next time I comment. 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. 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 indifferent curve is drawn from the indifference schedule of the consumer. As in case of change in price, rise in wage rate has both the substitution effect and income effect. All this means that the two perfect complements are used in a certain fixed ratio and cannot be substituted for each other In Fig. In this article we will discuss about Indifference Curves. 1. In the diagram, IC1 and IC2 are the two indifference curves. Thus, with the rise in wage rate, supply of labour has decreased by L0L1. 11.18(b). 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. 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. 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. Other uncategorized cookies are those that are being analyzed and have not been classified into a category as yet. Other uncategorized cookies are those that are being analyzed and have not been classified into a category as yet. It does not store any personal data. In its analysis, core principles of microeconomics are involved. These cookies will be stored in your browser only with your consent. These cookies will be stored in your browser only with your consent. Share Your Word File To do so we take away so much income from the individual that he comes back to the original indifference curve IC1. The indifference curve analysis work on a simple graph having two-dimensional. In the curve, the quantity consumed by B2 will compensate for the increase in the amount consumed by B2. 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. Thus PE, is money value of the subsidy to the individual. Required fields are marked *. It Studies Combinations of Two Goods Instead of One Good 3. The degree of convexity of an indifference curve depends upon the rate of fall in the marginal rate of substitution of X for Y. But the above principle regarding the programme of subsidised food, subsidised housing etc. With price line PL2 the individual is in equilibrium at point R on the indifference curve IC at which he is purchasing OA quantity of food. This is an important feature of an indifference curve. The indifference curve analysis measures utility ordinally. This cookie is set by GDPR Cookie Consent plugin. It is assumed that consumers preferences are monotonic i.e. Here, we understand that all three products resting in the indifferent curve give him the same satisfaction. Property II: Indifference curves are convex to the origin: Another important property of indifference curves is that they are usually convex to the origin. Since the food stamps are in addition to his initial income OB1 his budget line with food stamps becomes a kinked line B1 CL2. 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. As noted above, combination H is not available under food stamp subsidy because food stamps cannot be used to purchase other goods. And this indifference in prices defines the opportunity costs. That is why at point K in Fig. 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. 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. 200 he can buy 20 kg of food. (say apples), quantity of another good (say oranges) must fall so that the total satisfaction (utility) remains same. The importance of indifference curve analysis to neoclassical microeconomic consumer theory can hardly be overstated. 10 per kg., then with Rs. Answer (1 of 3): The following points highlight the top nine advantages of indifference curve technique over marshallian utility analysis. You may also have a look at the following articles to learn more , Your email address will not be published. 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. 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. The same argument holds good in this case as developed above in the case of intersection of indifference curves. If now the Government introduces a rationing for commodity X and fixes a ration of X equal to ORx (At point Rx we have shown a vertical line showing the constraint or ration limit imposed by the rationing fixed at ORx). This is directly plotted against the wage rate w0 in panel (b) of Fig. An indifference curve has a negative slope, i.e. Similarly, if a country has food surpluses and wants to dispose them of, then the food subsidy to the needy families will be the ideal measure to increase the consumption of food-grains and thereby to dispose of the food surpluses. 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. 11.20. 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. However, the more important and relevant case of rationing is depicted in Figure 11.8. Now, suppose with the introduction of rationing, ration limit R is fixed for good X and R, for good Y. You are free to use this image on your website, templates, etc., Please provide us with an attribution link. 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. We have taken only one schedule, but any number of schedules can be taken for the two commodities. 11.20. Microeconomics is a bottom-up approach where patterns from everyday life are pieced together to correlate demand and supply. In particular we are interested in knowing whether it is the ration limits or income of the consumer that is binding, that is, which forces the consumer to consume less amounts of the goods. 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. Disclaimer 9. The use of the indifference curve will help to judge the welfare effect of direct and indirect taxes on the individuals. 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. it helps to compare the satisfaction of different goods/commodities and enables the consumer to attain the equilibrium. Now suppose that wage rate rises to w1 with the result that income-leisure constraint line rotates to TM1. Assumptions of Indifference Curve. It makes the consumer indifferent to any of the combinations of goods shown as points on the curve. Combination L contains more of both goods X and Y than combination M on IC1. Answer (1 of 7): Indifference curve analysis is very important to the study of economics. 11.4 . (3) The consumer possesses complete information about the prices of the goods in the market. To break up this wage effect on labour supply, we reduce his money income by compensating variation in income. The cookies is used to store the user consent for the cookies in the category "Necessary". Supply curve of labour shows how an individuals work effort responds to changes in the wage rate. Given this money income and given the market price of food, the price line is PLX. It may be noted that income of a consumer along with the prices of goods serves as a constraint on his choices and is often called a budget constraint. Pen and ink, right shoe and left shoe, automobile and petrol sauce and hamburger, type writer and typists are some examples of perfect complements. With these stamps, the recipient can buy food and only food. 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. 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. Share Your PPT File. You also have the option to opt-out of these cookies. AB is tangent to indifference curve IC1 at point S at which he supplies TL2 hours for work. It helps us visualize the different combinations of goods and services, each of which yields the same level of utility. The superiority of cash grant in terms of its impact on the welfare of the individuals can be explained in a slightly different way. An indifference curve shows all combinations of goods that provide an equal level of utility or satisfaction. It is, important to note that income is earned by devoting some of the leisure time to do some work. In this optimal situation, income- leisure trade off (i.e. You can calculate it by, 3.Indifference curve shows various possible combinations of two goods that give equal satisfaction to the consumer. TL1 is the hours worked at the wage rate w represented by the slope of the income-leisure line MT. 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. While leisure yields satisfaction to the individual directly, income represents general purchasing power capable of being used to buy goods and services for satisfaction of various wants. 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. Alternatively, the slope of the curve indicates the marginal rate of substitution between two goods. In short, the first condition of the consumer's equilibrium is that the budget or price line should be tangent to the indifference curve. The second possibility of the effect of food stamp subsidy is illustrated in Fig. Irish-born British economist Francis Ysidro Edgeworth first proposed this two-dimensional graph, also known as the iso-utility curve. Property I. Indifference curves slope downward to the right: This property implies that an indifference curve has a negative slope. Consider indifference curves IC1 and IC2 in Fig. 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 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. 1 unit of cloth and 8 units of the indifference curve concerns only one,... Taxes on the welfare effect of food stamp subsidy of B1C the individual has to a... 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