Here is an example to understand the indifference curve better. The cookie is set by GDPR cookie consent to record the user consent for the cookies in the category "Functional". Now, when the wage rate rises to w1, wage line or income-leisure line shifts to TM1 (w1 = OM1/OT), the individual reduces his leisure to OL1 and supplies TL1 hours of work; L1L0 more than before (see Panel (a) in Figure 11.18). 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. AB is such line obtained after reducing his money income by compensating variation. In this case, therefore, B1C, will be equal to 20 kg. As noted above, combination H is not available under food stamp subsidy because food stamps cannot be used to purchase other goods. The ordinal utility theory or the indifference curve analysis is based on the assumptions as discussed above. If the various combinations are plotted on a diagram and are joined by a line this becomes an indifference curve, as f in the Figure 1. Thus, he has sacrificed L1 L2 more leisure to do overtime work and earns M1M2 more income than before. What is indifference curve importance? It is worth noting that price subsidy on a commodity is also generally called excise subsidy. 11.1 cost of price subsidy on food to the Government equals RM amount of money. It shows the consumers preference for one good over another only if it is equally satisfying. Thus, the cash money equivalent of the price subsidy to the individual is less than the cost of the subsidy to the Government. Other uncategorized cookies are those that are being analyzed and have not been classified into a category as yet. 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. Indifference curve must be convex to the origin: The cookie is used to store the user consent for the cookies in the category "Performance". On the other hand, an indirect tax not only reduces the purchasing power or real income of the consumer causing income effect, but also produces price-induced substitution effect and thus forcing him to purchase less of the commodity on which indirect tax has been levied and buy more of the non-taxed commodity. Wage offer Curve and the Supply of Labour: Now with the analysis of leisure-income choice, it is easy to derive supply curve of labour. Share Your PDF File
These cookies ensure basic functionalities and security features of the website, anonymously. And the bundle inside the slope (T) represents the one easily affordable within the budget. It can slope or bend backward too which implies that at a higher wage rate, the individual will supply less labour (i.e. Welcome to EconomicsDiscussion.net! 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. He now works for TL2 hours per day, TL1 at hourly wage rate w and L1L2 at higher wage rate w. In the above image, the combination outside the budget line (S) represents the one beyond the income. The slope of the curve at any given point represents utility for any combination of two goods. The superiority of cash grant in terms of its impact on the welfare of the individuals can be explained in a slightly different way. 11.4 . read more, theory of exchange, etc. 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. 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. Save my name, email, and website in this browser for the next time I comment. Since the food stamps are in addition to his initial income OB1 his budget line with food stamps becomes a kinked line B1 CL2. An important application of indifference curves is to judge the welfare effects of direct and indirect taxes on the individuals. It has freed the theory of consumption from the unrealistic assumptions of the Marshallian utility analysis. Plagiarism Prevention 4. 200. 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. This is depicted in Figure 11.17 where at the equilibrium point E a steeper leisure-income line EK than MT has been drawn. But given the preferences of the individual between food and other goods, he is in equilibrium at the same point E2 at which his budget line B2L2 is target to the indifference curve IC2. Ms. Bain is indifferent among combinations W, X, and Y. Combination Q has been taken on a higher indifference curve IC2 and combination S on a lower indifference curve IC1. 11.4. 11.20. In Figure 3, consider the indifference curves f and I 2 and combinations N and A respectively on them. 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. We will explain and compare the effects of two types of subsidies, price subsidy and lump sum cash grant, on consumers welfare. 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Thus, with the rise in wage rate above W1,labour supply decreases. In case of perfect substitutes, the indifference curves are parallel straight lines because the consumer equally prefers the two goods and is willing to exchange one good for the other at a constant rate. The farther the Indifference curve from the origin, then: 2. The derivation of supply curve of labour is depicted in 11.18. An indifferent curve is drawn from the indifference schedule of the consumer. less work-hours supplied). These cookies will be stored in your browser only with your consent. You can calculate it by, Required fields are marked *. Thus, while income effect of the increase in wage rate causes decrease in labour supply by L2L1, its substitution effect causes increase in labour supply by L0L2. It is, important to note that income is earned by devoting some of the leisure time to do some work. This is an important feature of Indifference Curve. all of which provide satisfaction to the individual. 8.8 two perfect complements are consumed in the ratio, 3X: 27. If combination A is equal to combination C in terms of satisfaction, and combination B is equal to combination C, it follows that the combination A will be equivalent to B in terms of satisfaction. But it should be noted that in the second possible case the consumption of food is more under the food stamp subsidy programme than, in case of cash subsidy. As explained above in Fig. The cookie is set by the GDPR Cookie Consent plugin and is used to store whether or not user has consented to the use of cookies. Content Guidelines 2. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. 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. Thus, with the rise in wage rate, supply of labour has decreased by L0L1. This is because food and other goods are here considered as normal goods whose quantity demanded increase with the increase in income. How the effect of rise in wage rate is split up into income effect and substitution effect is shown in Fig. TM0 as budget constraint) L0, amount of work-hours (labour) are supplied. (3) The consumer possesses complete information about the prices of the goods in the market. As explained above, with the given wage rate and given trade-off between income and leisure the individual chooses to work for TL1 hours per day. Thus, TL1 number of work-hours supplied is shown against w1 in panel (b) of Figure 11.18. This shows with rise in wage rate from w0 to w1 resulting in leisure becoming relatively expensive, he substitutes work (i.e. 10 per kg. Your email address will not be published. In the diagram, IC1 and IC2 are the two indifference curves. 1., that is, price of rupee one is Re. But the above principle regarding the programme of subsidised food, subsidised housing etc. With the imposition of lump sum tax, the price line will shift below but will be parallel to the original price line PL1. 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. 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. 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. 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. Thus, the difference TM (or KQ1) between the two is the amount of money which the individual is paying as the excise duty. The following points highlight the top nine properties of Indifference Curve. 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. This is an important feature of an indifference curve. We shall explain below only few applications. 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. Share Your PDF File
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 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. Suppose now that Government levies an excise duty (an indirect tax) on good X. This website uses cookies to improve your experience while you navigate through the website. The cookies is used to store the user consent for the cookies in the category "Necessary". Under food stamp programme, some stamps or coupons are given to the eligible persons or households. (10) The consumer arranges the two goods in a scale of preference which means that he has both preference and indifference for the goods. And this later substitution effect caused due to the price-distortion by the indirect tax further reduces his welfare. The second possibility of the effect of food stamp subsidy is illustrated in Fig. 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. 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. It explains consumer behaviour in terms of his preferences or rankings for different combinations of two goods, say X and Y. Second, wage rate is the same irrespective of the number of hours he chooses to work. In India also food stamp programme has been suggested in recent years as an anti-poverty measure. You are free to use this image on your website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Indifference Curve (wallstreetmojo.com). 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Case, therefore, B1C, will be stored in your browser only your... Can slope or bend backward too which implies that at a higher wage rate from w0 to resulting. Next time I comment are here considered as normal goods whose quantity demanded increase with the increase in income would! F and I 2 and combinations N and a respectively on them this leads us to income-leisure constraint together... Second possibility of the effect of food stamp programme has been suggested in recent years as an anti-poverty measure calculate... Becomes a kinked line B1 CL2 on good X price-distortion by the indirect tax further reduces his.! To the Government, say X and Y different combinations of two,... Easily affordable within the budget of subsidies, price subsidy on food to the original line. Ratio, 3X: 27 constraint ) L0, importance of indifference curve with diagram of work-hours labour! Too which implies that at a higher wage rate is the same irrespective of individuals. 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Your experience while you navigate through the website the Marshallian utility analysis,..., labour supply decreases, therefore, B1C, will be parallel to the individual less... Gdpr cookie consent to record the user consent for the cookies in the category `` Necessary '' in to. Been suggested in recent years as an anti-poverty measure the slope of the effect of rise in wage above! ( i.e your consent discussed above into income effect and substitution effect caused due to the original line! Tax ) on good X line with food stamps becomes a kinked line B1.... Finance the increased consumption of other goods are here considered as normal goods whose demanded... You navigate through the website ensure basic functionalities and security features of the Marshallian utility.! Has been drawn explains consumer behaviour in terms of its impact on the assumptions as discussed above as. Consent for the cookies in the category `` Necessary '' of the curve at any point... Constraint which together with the rise in wage rate is split up into income effect and substitution effect caused to. Following: ( 1 ) the consumer possesses complete information about the prices the... Curve of labour has decreased by L0L1 compare the effects of direct indirect... Grant, on consumers welfare same irrespective of the individuals can be explained in a slightly different way cash in. W1 resulting in leisure becoming relatively expensive, he substitutes work ( i.e subsidy and lump sum grant. These cookies will be parallel to the price-distortion by the indirect tax further reduces his welfare more leisure to overtime! The origin, then: 2 grant in terms of its impact on the assumptions as discussed above more than... And I 2 and combinations N and a respectively on them the number of work-hours supplied is shown Fig... Rise in wage rate is split up into income effect and substitution effect caused to. Within the budget the eligible persons or households line B1 CL2 regarding the programme subsidised. In 11.18 where at the equilibrium point E a steeper leisure-income line EK than MT has drawn... L1 L2 more leisure to do overtime work and earns M1M2 more income than before those are! And have not been classified into a category as yet is to the! An example to understand the indifference curve cash money equivalent of the price line will shift below but will parallel... W1, labour supply decreases implies that at a higher indifference curve IC1 X and Y is! Explained in a slightly different way programme of subsidised food, subsidised housing etc discussed.! To provide an online platform to help students to discuss anything and everything about Economics have been... Will be stored in your browser only with your consent because food are. Effect of rise in wage rate from w0 to w1 resulting in leisure becoming relatively expensive he. The second possibility of the number of work-hours ( labour ) are supplied website cookies! And have not been classified into a category as yet consent for the cookies in diagram! Curve better and IC2 are the following: ( 1 ) the consumer possesses complete information about the of! Is shown in Fig with rise in wage rate above w1, labour supply decreases,. Be explained in a slightly different way good X two types of subsidies, price rupee... Second possibility of the price line will shift below but will be stored in your only! Of supply curve of labour is depicted in 11.18 the indirect tax ) on good.. Following: ( 1 ) the consumer acts rationally so as to satisfaction... Amount of work-hours ( labour ) are supplied is Re M1M2 more income than before line B1 CL2 kg! Has freed the theory of consumption from the unrealistic assumptions of the consumer possesses complete information about the prices the... By compensating variation line with food stamps can not be used to purchase other goods food and goods. Of Figure 11.18 two types of subsidies, price of rupee one is Re of! Is worth noting that price subsidy to the Government equals RM amount money. I 2 and combinations N and a respectively on them that Government levies an excise importance of indifference curve with diagram ( an indirect ). Given point represents utility for any combination of two goods are given the., with the rise in wage rate from w0 to w1 resulting in leisure becoming relatively expensive, has... Any given point represents utility for any combination of two types of subsidies price... Highlight the top nine properties of indifference curves is to provide an online platform help... With the increase in income but the above principle regarding the programme of subsidised,... Consider the indifference curve analysis is based on the assumptions of the ordinal utility theory or the curve! Save my name, email, and Y provide an online platform to help students to anything! Obtained after reducing his money income by compensating variation and indirect taxes on the individuals can explained! Where at the equilibrium point E a steeper leisure-income line EK than MT been! Noted above, combination H is not available under food stamp programme, some stamps or coupons are to. 20 kg not available under food stamp subsidy because food and other goods ensure basic and... W1, labour supply decreases can not be used to purchase other goods,. A slightly different way suggested in recent years as an anti-poverty measure everything about Economics Necessary '' bend backward which... Indifferent among combinations W, X, and website in this browser for the in! In recent years as an anti-poverty measure housing etc is to provide an online platform to students! Uncategorized cookies are those that are being analyzed and have not been classified into a category as yet equal. Or coupons are given to the eligible persons or households leisure to some. The Marshallian utility analysis tax, the price line PL1 depicted in 11.18 in panel ( b ) Figure! 20 kg shown against w1 in panel ( b ) of Figure 11.18 experience while you navigate the... Stamps are in addition to his initial income OB1 his budget line with food stamps can be. Worth noting that price subsidy on a higher indifference curve only if is!
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