Thus income provides satisfaction indirectly. An indifference curve is a graphical representation of various combinations or consumption bundles of two commodities. It does not store any personal data. 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. 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. 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. In other words, at point Q2 individuals level of welfare is higher than at Q1. In particular, mention may be made of consumer's equilibrium, derivation of the demand curve and the concept of . 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. Thus, with the rise in wage rate above W1,labour supply decreases. Choice of other points on income-leisure line MT will show different amounts of leisure, income and work. The technique of the indifference curve can be used for choosing between direct and indirect taxes. 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. The second possibility of the effect of food stamp subsidy is illustrated in Fig. Consider Figure 11.5 where on the X-axis, good X and on the F-axis money is measured. Thus, in this case, rationing is actually binding for the consumer and reduces his welfare. 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. Thus, in Figure 11.5, imposition of an equivalent lump-sum or income tax, the consumer moves from the equilibrium position Q3 on indifference curve IC3 to the new position Q2 on indifference curve IC2 which represents the income effect. Disclaimer Copyright, Share Your Knowledge 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. it provides an ordinal measurement of utility. A single indifference curve concerns only one level of satisfaction. This cookie is set by GDPR Cookie Consent plugin. It helps us visualize the different combinations of goods and services, each of which yields the same level of utility. 11.20. The use of the indifference curve will help to judge the welfare effect of direct and indirect taxes on the individuals. With the budget line BL and the rationed quantity Rx he will be at point E which lies at lower indifference curve IC0. 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. In the above image, the combination outside the budget line (S) represents the one beyond the income. Where the X-axis indicates one commodity (Cloth) and Y-axis refers to another good (Book). One possibility is that with the food-stamp subsidy and resultant kinked budget line B1CL2, in Fig. In its analysis, core principles of microeconomics are involved. Hence, relief payments in cash are preferable to a food subsidy because they are economically more efficient, giving the relief receipts either a greater gain at the same cost to the Government or the same gain at a lower cost.. He decides to exchange 4 units of books for an additional piece of cloth. It makes the consumer indifferent to any of the combinations of goods shown as points on the curve. The cookie is used to store the user consent for the cookies in the category "Performance". This cookie is set by GDPR Cookie Consent plugin. Second, wage rate is the same irrespective of the number of hours he chooses to work. 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. The curve slopes downward as the consumption of commodity A increases in exchange for commodity B. In India also food stamp programme has been suggested in recent years as an anti-poverty measure. an indifference curve helps the consumer to determine . (4) The prices of the two goods are given. Given this money income and given the market price of food, the price line is PLX. We cannot predict the specific result purely on theoretical grounds. The greater the fall in marginal rate of substitution, the greater the convexity of the indifference curve. will work for less hours). This is an important feature of an indifference curve. 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. 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 degree of convexity of an indifference curve depends on the rate of fall in the marginal rate of substitution of X for Y. 11.1 cost of price subsidy on food to the Government equals RM amount of money. 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. 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. It could be calculated by dividing the additional utility by the amount of additional units. As will be seen from Figure 11.5, as a result of income effect of the indirect tax the consumer moves from point Q3 on indifference curve IC3 to point Q2 on lower indifference curve IC2 and as a result of substitution effect he is further pushed to point Q1 on still lower indifference IC1. Our analysis is based on two assumptions. 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. (11) Both preference and indifference are transitive. Before publishing your Articles on this site, please read the following pages: 1. it slopes downward from left to right. With a given money income OB1 of an individual and given market price of food, B1L1 is the budget line whose slope represents the price of food (Note that price of money represented on the X-axis is Re. 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. Thus, the cash money equivalent of the price subsidy to the individual is less than the cost of the subsidy to the Government. An indifference curve denotes a set of different combinations of two commodities or goods, providing the same level of satisfaction to the consumer. With the imposition of lump sum tax, the price line will shift below but will be parallel to the original price line PL1. Here we discuss the properties of the indifference curve and how to analyze it, along with examples and assumptions. In this case with cash subsidy the individual spends more than his initial income OB1 on other goods. Straight-line indifference curves of perfect substitutes are shown m Fig. Privacy Policy 8. You also have the option to opt-out of these cookies. 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. Higher indifference curve represents larger bundles of goods i.e. 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. Since the food stamps are in addition to his initial income OB1 his budget line with food stamps becomes a kinked line B1 CL2. Since all the combinations give the same amount of satisfaction, the consumer prefers them equally. Thus, the cash transfer equivalent to the cost of price subsidy has led to the greater increase in welfare or satisfaction of the individual as compared to the price subsidy. In other words, an indifference curve shows the different bundles of goods that a person is indifferent between, as they all provide the same level of utility or satisfaction to the individual. An important application of indifference curves is to judge the welfare effects of direct and indirect taxes on the individuals. The following diagram showing an indifference map consisting of three curves: We know that a consumer is indifferent among the combinations lying on the same indifference curve. 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. As will be seen in Fig. goods other than food). It is worth noting that price subsidy on a commodity is also generally called excise subsidy. With stamps of Rs. If the individual can work for all the 24 hours in a day, he would earn income equal to OM. An indifference curve has a negative slope, i.e. 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. Answer (1 of 7): Indifference curve analysis is very important to the study of economics. 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. 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. Indifference curves between income and leisure are therefore also called trade-off curves. 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. Each individual axis indicates a single type of economic goods. Several kinds of subsidies are paid to the individuals these days by the Government for promoting welfare of the people. 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. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. Suppose that under food-subsidy programme, the needed families are entitled to purchase food at half the market price, the other half of the market price is paid by the Government as subsidy. Now, suppose the individual is given food stamps of Rs. You are free to use this image on your website, templates, etc., Please provide us with an attribution link. Since PT amount of money is paid by the individual himself, the remaining amount TN or RM (the vertical distance between the price lines PL1 and PL2 at OA amount of food) is paid by the Government as food subsidy for the individual. You consent to our cookies if you continue to use our website. 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 is a form of in-kind food subsidy in contrast to the subsidy provided in the form of cash income, often called cash subsidy. Thus, the slope of the income-leisure curve OM/OT equals the wage rate. 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. However, the actual choice of income and leisure by an individual would also depend upon what is the market rate of exchange between the two, that is, the wage-rate per hour of work. You also have the option to opt-out of these cookies. It comprises individual choices, marginal utilityMarginal UtilityA customer's marginal utility is the satisfaction or benefit derived from one additional unit of product consumed. 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. The indifference curve analysis work on a simple graph having two-dimensional. This shows with rise in wage rate from w0 to w1 resulting in leisure becoming relatively expensive, he substitutes work (i.e. With the imposition of excise duty, the price of good X will rise. The cookie is used to store the user consent for the cookies in the category "Analytics". Other uncategorized cookies are those that are being analyzed and have not been classified into a category as yet. Further, if the same amount of revenue is to be raised through lump-sum tax as with the excise duty, then the new price line AB should be drawn at such a distance from the original price line PL1 that it passes through the point Q1. Let us consider commodities B1 and B2. 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. Economists have adopted the principles of. The cookies is used to store the user consent for the cookies in the category "Necessary". It explains consumer behaviour in terms of his preferences or rankings for different combinations of two goods, say X and Y. 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. As stated above, when two goods are perfect substitutes of each other, the indifference curve is a straight line on which marginal rate of substitution remains constant. (7) An indifference curve is negatively inclined sloping downward. Further, these stamps cannot be traded or transferred to the other people. It does not store any personal data. The indifference curve slopes down from left to right on the graph. This is directly plotted against the wage rate w0 in panel (b) of Fig. 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. Thus PE, is money value of the subsidy to the individual. Lump-sum tax has reduced the individuals welfare less than that by the excise duty. These cookies help provide information on metrics the number of visitors, bounce rate, traffic source, etc. This is an important feature of Indifference Curve. Combination Q has been taken on a higher indifference curve IC2 and combination S on a lower indifference curve IC1. 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. 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. With this extra cash transfer equal to RM (-PC), the budget-line will shift to the right to the position CD in Fig. This website uses cookies to improve your experience while you navigate through the website. Image Guidelines 5. IC2 is a higher indifference curve than IC1. With given income of the consumer and prices of the two goods we draw a budget line BL in Figure 11.6. Welcome to EconomicsDiscussion.net! Jack has 1 unit of cloth and 8 units of the book. Required fields are marked *. Share Your PPT File. It Provides a . To do so we take away so much income from the individual that he comes back to the original indifference curve IC1. The latter shows the various combinations of the two commodities such that the consumer is indifferent to those combinations. As a result of the rise in price of good X, the price line rotates to a new position PL2 which is tangent to indifference curve IC1 at point Q1. The cookie is set by GDPR cookie consent to record the user consent for the cookies in the category "Functional". These cookies will be stored in your browser only with your consent. It could be calculated by dividing the additional utility by the amount of additional units.read more theory, the subjective theory of value, substitution effects, income, ordinal utility, etc. 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. 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. This is quite evident from panel (b) of Fig. Budget Line: Notes on Budget Line, Space, Changes and Slope. You can calculate it by, CFA And Chartered Financial Analyst Are Registered Trademarks Owned By CFA Institute. And this indifference in prices defines the opportunity costs. Hence, a consumer prefers to reach the tallest line to attain a higher utility level. It will be seen from Figure 11.1 that budget line EF touches the indifference curve IC at a point S and is buying OB quantity of 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. Figure 11.16 displays income-leisure equilibrium of the individual. Supply curve of labour shows how an individuals work effort responds to changes in the wage rate. he always prefers larger bundle as it gives him higher satisfaction. This result is of special importance because supporters of food-stamp subsidy have been emphasizing that food subsidy should not be used to finance any part of nonfood unnecessary items such as liquor. We use cookies to personalise content and ads, to provide social media features and to analyse our traffic. They slope downward to the right, are convex to the origin and do not intersect. These cookies will be stored in your browser only with your consent. You may also have a look at the following articles to learn more , Your email address will not be published. Thus, his preferences are such that rationing is not actually binding for him. An indifference map between income and leisure is depicted in Figure 11.14 and has all the usual properties of indifference curves. Jack is satisfied with 1 unit of cloth and 8 units of books. The importance of indifference curve analysis to neoclassical microeconomic consumer theory can hardly be overstated. At the old price (before the excise duty was imposed), he could purchase ON quantity of good X for PT amount of money. 1.). Likewise, when the wage rate rises to w2 (w2, = OM2/ OT), income-leisure line shifts to TM2 the individual chooses to have leisure time OL2 and supplies TL1 work-hours. It's essentially the cost of the next best alternative that has been forgiven.