he always prefers larger bundle as it gives him higher satisfaction. That is, income is earned by sacrificing some leisure. The second possibility of the effect of food stamp subsidy is illustrated in Fig. This website includes study notes, research papers, essays, articles and other allied information submitted by visitors like YOU. This trade-off means how much income the individual is willing to accept for one hour sacrifice of leisure time. 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. It can slope or bend backward too which implies that at a higher wage rate, the individual will supply less labour (i.e. Consumers would prefer to move in the direction indicated by the arrow in the figure. Lump sum tax, proportionate and progressive income taxes, wealth tax, death duty are the examples of direct tax. Where the X-axis indicates one commodity (Cloth) and Y-axis refers to another good (Book). An indifference map between income and leisure is depicted in Figure 11.14 and has all the usual properties of indifference curves. With given income of the consumer and prices of the two goods we draw a budget line BL in Figure 11.6. This shows that a part of food stamp subsidy is indirectly used to finance the increased consumption of other goods. IC2 is a higher indifference curve than IC1. Thus, the difference TM (or KQ1) between the two is the amount of money which the individual is paying as the excise duty. (8) An indifference curve is always convex to the origin. labour supply) L0L2 for leisure. However, the more important and relevant case of rationing is depicted in Figure 11.8. 10 per kg., then with Rs. document.getElementById( "ak_js_1" ).setAttribute( "value", ( new Date() ).getTime() ); Copyright 2023 . It Provides a . The utility is expressed in terms of ordinal numbers. 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. Share Your PDF File These combinations provide the same level of satisfaction and utility to the consumer. Hence IC2 curve gives more satisfaction. The maximum amount of time available per day for the individual is 24 hours. For instance, a child might be indifferent while having a toy, two comic book, four toy trucks and a single comic book. You may also have a look at the following articles to learn more , Your email address will not be published. (4) The prices of the two goods are given. The cookie is used to store the user consent for the cookies in the category "Other. But ration limit Rx for good X is larger than his optimum or equilibrium consumption quantity of good X. 8.8 two perfect complements are consumed in the ratio, 3X: 27. 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. Corporate valuation, Investment Banking, Accounting, CFA Calculation and others (Course Provider - EDUCBA), * Please provide your correct email id. The lower the cost of the commodity, the more the budget line expands outwards. On the other hand, in case of good, case of good X in Figure 11.10 the ration limit Rx does not seem to be effective, though it is potentially binding as it truncates his market opportunity set. We will further show how much K work effort (i.e. It is assumed that consumers preferences are monotonic i.e. What is indifference curve importance? 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. 11.18(b). Therefore, with subsidy the individual will face the price line PL2 where OL1 = L1 L2. The use of the indifference curve will help to judge the welfare effect of direct and indirect taxes on the individuals. (10) The consumer arranges the two goods in a scale of preference which means that he has both preference and indifference for the goods. it slopes downward from left to right. 8.8. Thus the trade-off between income and leisure at this point is M/L. 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. 11.1 cost of price subsidy on food to the Government equals RM amount of money. 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. You are free to use this image on your website, templates, etc., Please provide us with an attribution link. Indifference curves are heuristic devices used in contemporary microeconomics to demonstrate consumer preference and the limitations of a budget. It follows that PE is less than RM. An indifference curve is a graphical representation of various combinations or consumption bundles of two commodities. A normal indifference curve will be convex to the origin and it cannot be concave. This website includes study notes, research papers, essays, articles and other allied information submitted by visitors like YOU. By purchasing OA quantity of food, the individual is spending PT amount of money. 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. TOS 7. At different income-leisure levels, the trade-off between leisure and income varies. It comprises individual choices, marginal utilityMarginal UtilityA customer's marginal utility is the satisfaction or benefit derived from one additional unit of product consumed. Likewise, the combinations B and C will give equal satisfaction to the consumer; both being on the same indifference curve IC1. This property follows from assumption I. 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. Now, the important question is what is the money value of this price subsidy (RM) on food to the individual. 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. 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. With the imposition of excise duty, the price of good X will rise. Since all the combinations give the same amount of satisfaction, the consumer prefers them equally. 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. 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. He now works for TL2 hours per day, TL1 at hourly wage rate w and L1L2 at higher wage rate w. Property I. Indifference curves slope downward to the right: This property implies that an indifference curve has a negative slope. These cookies will be stored in your browser only with your consent. 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. 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. This means for most of the recipients, food stamp programme has the same effect as a cash subsidy. Let us suppose that the individual has OP money income. This cookie is set by GDPR Cookie Consent plugin. That is, at wage rate w0he supplies TL0 amount of labour. Meaning of Indifference Curve 2. The indifference curve I1 is the locus of the points L, M, N, P, Q, and R, showing the combinations of the two goods X and Y between which the consumer is indifferent. These cookies will be stored in your browser only with your consent. An important application of indifference curves is to judge the welfare effects of direct and indirect taxes on the individuals. The indifference curve slopes down from left to right on the graph. Since all consumption bundles give an equal amount of utility, the consumer is indifferent to all combinations. For example, Dalda and Rath Vanaspati, two different brands of cold drink such as Pepsi Cola and Coca Cola are generally considered to be perfect substitutes of each other. Further, these stamps cannot be traded or transferred to the other people. Share Your Word File 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. Thus, with the rise in wage rate above W1,labour supply decreases. 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. Necessary cookies are absolutely essential for the website to function properly. But the above principle regarding the programme of subsidised food, subsidised housing etc. Such a situation arises because a consumer consumes a large number of goods and services. 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. 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. Now, if no food subsidy was given and therefore the price line was PL1, then for buying OA quantity of food, the individual would have spent PN amount of money. The basic reason for this is that whereas both the lump-sum tax (or any other general income tax) and an indirect tax reduce consumers income and produce income effect, the indirect tax in addition to the income effect, also raises the relative price of the good on which it is levied and therefore causes substitution effect. Theindifference curve in economicsexamines demand patterns for commodity combinations, budget constraints and helps understand customer preferences. will work for less hours). The indifference curve indicates the various combinations of two goods that yield equal satisfaction to the consumer. An indifference curve is a downward sloping convex line connecting the quantity of one good consumed with the amount of another good consumed. 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. Welcome to EconomicsDiscussion.net! To do so we take away so much income from the individual that he comes back to the original indifference curve IC1. For instance, if price of food is Rs. To break up this wage effect on labour supply, we reduce his money income by compensating variation in income. Some of the advantages are: 1. 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). Thus, the slope of the income-leisure curve OM/OT equals the wage rate. This cookie is set by GDPR Cookie Consent plugin. Thus, indirect tax (excise duty) causes an excess burden on the individual. 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. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. Consider indifference curves IC1 and IC2 in Fig. In the curve, the quantity consumed by B2 will compensate for the increase in the amount consumed by B2. Consumers can rank a combination of commodities based on their satisfaction levels. It helps us visualize the different combinations of goods and services, each of which yields the same level of utility. That is, income effect of the rise in wage rate on leisure is positive, that is, leads to the increase in the hours of leisure enjoyed (that is, tends to decrease labour supply). We therefore conclude that indifference curves cannot cut each other. 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. 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. We also use third-party cookies that help us analyze and understand how you use this website. The latter shows the various combinations of the two commodities such that the consumer is indifferent to those combinations. Combinations or consumption bundles give an equal amount of money the different combinations of goods services! By GDPR cookie consent plugin finance the increased consumption of other goods, stamps. 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