An indifference curve is a graph showing combination of two goods that give the consumer equal satisfaction and utility. In geometric terms, it will be seen from Figure 11.14 that on indifference curve IC1 at point A the individual is willing to accept M income for sacrificing an hour (L) of leisure. They may represent higher or lower satisfaction of the consumer. Share Your PPT File. An indifference curve is a graph that represents the different combinations of two goods that give an individual the same level of satisfaction or utility. This means that if individual is paid PE amount of money (say as a cash grant), he reaches the same indifference curve IC (same level of welfare) at which he is when price subsidy is paid by the Government on food. 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. (say apples), quantity of another good (say oranges) must fall so that the total satisfaction (utility) remains same. An indifference curve denotes a set of different combinations of two commodities or goods, providing the same level of satisfaction to the consumer. Since A is on a higher . Such a situation arises because a consumer consumes a large number of goods and services. Meaning of Indifference Curve 2. Examples of goods that are perfect substitutes are not difficult to find in the real world. At this new equilibrium point E2 he is purchasing Of2 quantity of food and ON2 of other goods. But opting out of some of these cookies may affect your browsing experience. Thus, the slope of the income-leisure curve OM/OT equals the wage rate. This cookie is set by GDPR Cookie Consent plugin. The consumer is expected to buy any of the two commodities in a combination. You also have the option to opt-out of these cookies. 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. For instance, a child might be indifferent while having a toy, two comic book, four toy trucks and a single comic book. The cookie is used to store the user consent for the cookies in the category "Analytics". Thus, if a person chooses combination C, this means that he has OL1 amount of leisure time and OM1 amount of income. These cookies will be stored in your browser only with your consent. We shall study below that indirect tax such as excise duty income causes excess burden on the individuals, that is, indirect tax reduces welfare more than the direct tax, say income tax when an equal amount of revenue is raised through them. Therefore, RM is also greater than PE. Hence, a consumer prefers to reach the tallest line to attain a higher utility level. 200. Welcome to EconomicsDiscussion.net! Advertisement cookies are used to provide visitors with relevant ads and marketing campaigns. Each indifference curve represents various alternative combinations of income and leisure which provides equal level of satisfaction to the individual and the farther away an indifference curve is from the origin, the higher the level of satisfaction it represents for the individual. 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. (10) The consumer arranges the two goods in a scale of preference which means that he has both preference and indifference for the goods. Share Your Word File The indifference curve analysis retains some of the assumptions of the cardinal theory, rejects others and formulates its own. Assumptions of Indifference Curve. 11.20), the greater amount of labour L1 is supplied, which is greater than L0. 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. Therefore, given that the consumer is free to spend money as he likes, with cash grant his new equilibrium position must be to the left of point R on the budget line CD where it will be tangent to the higher indifference curve than IC2. It is evident from Fig. With this extra cash transfer equal to RM (-PC), the budget-line will shift to the right to the position CD in Fig. 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. However, it is important to note that he . 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. Price-Income Line or Budget Line (With Diagram). Pen and ink, right shoe and left shoe, automobile and petrol sauce and hamburger, type writer and typists are some examples of perfect complements. This website includes study notes, research papers, essays, articles and other allied information submitted by visitors like YOU. Share Your PDF File Consumer goods companies and the industry offer a vast range of products that heavily contribute to the global economy.read more, the curve features unique combinations or consumption bundles for any two commodities in points. When a consumer wants to have more of a commodity, he/she will have to give up some of the other commodity, given that the consumer remains on the same level of utility at constant income. 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. This cookie is set by GDPR Cookie Consent plugin. Consumers can rank a combination of commodities based on their satisfaction levels. all of which provide satisfaction to the individual. an indifference curve helps the consumer to determine . Meaning of Indifference Curve: The indifference curve analysis measures utility ordinally. 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. One of the properties of the indifference curve is that it is strictly convex and never concave. Further, he is better off than before as he is now at the higher indifference curve IC2. Introduction to Indifference Curve and Perfect Substitutes. If, for instance, the amount of good X is increased in the combination, while the amount of good Y remains unchanged, the new combination will be preferable to the original one and the two combinations will not therefore lie on the same indifference curve provided more of a commodity gives more satisfaction. According to Watson, An indifference schedule is a list of combinations of two commodities the list being so arranged that a consumer is indifferent to the combinations, preferring none of any other. The following is an imaginary indifference schedule representing the various combinations of goods X and Y. Thus the food subsidy has induced the individual to consume more food than in case of cash payment. An important application of indifference curves is to judge the welfare effects of direct and indirect taxes on the individuals. CFA And Chartered Financial Analyst Are Registered Trademarks Owned By CFA Institute. 11.8 he is at lower indifference curve IC0 indicating his lower level of welfare. 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. Since all consumption bundles give an equal amount of utility, the consumer is indifferent to all combinations. 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. 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. If a consumer purchases two goods, the budget limitation can be displayed with the help of a budget line on a graph. 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. 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. Another important result obtained from our above analysis is that even with food stamps programme the individual increases the consumption of all other goods (i.e. It explains consumer behaviour in terms of his preferences or rankings for different combinations of two goods, say X and Y. The importance of indifference curve analysis to neoclassical microeconomic consumer theory can hardly be overstated. 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. 200 provided to him, while spending his entire income OB on other goods. The relationship between marginal utility and demand curve is an important concept in economics that helps to explain how consumers make decisions about what to purchase and at what price. Complements are thus those goods which are used jointly in consumption so that their consumption increases or decreases simultaneously. Where the X-axis indicates one commodity (Cloth) and Y-axis refers to another good (Book). If the graph is on the curve or line, then it means that the consumer has no preference for any goods, because all the good has the same level of satisfaction or utility to the consumer. The curve slopes downward as the consumption of commodity A increases in exchange for commodity B. CFA Institute Does Not Endorse, Promote, Or Warrant The Accuracy Or Quality Of WallStreetMojo. It means that the price ratio of commodity-1 and commodity-2 should be equal to the marginal rate of substitution of commodity-1 for commodity-2. In our Figure PE = MK (the vertical distance between two parallel lines) and RM is greater than MK. 11.3 the individual maximises his satisfaction at point E2 where his budget line is tangent to indifference curve IC2. 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. The less the ease with which two goods can be substituted for each other, the greater will be the fall in the marginal rate of substitution. Share Your Word File Lump-sum tax has reduced the individuals welfare less than that by the excise duty. Since all the combinations give the same amount of satisfaction, the consumer prefers them equally. Some of the advantages are: 1. It allows the consumer to buy within a given budget, i.e., within their current income. These cookies help provide information on metrics the number of visitors, bounce rate, traffic source, etc. 11.20. 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. 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. A normal indifference curve will be convex to the origin and it cannot be concave. 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. It's essentially the cost of the next best alternative that has been forgiven.read more play a crucial role in the curve analysis. The farther the Indifference curve from the origin, then: 2. It will be seen from Figure 11.19 that TM0 is tangent to indifference curve IC1 between leisure and income at point R. Thus, with wage rate w0the individual is in equilibrium when he enjoys OL0 leisure and therefore he is supplying TL0 work hours of labour. We also use third-party cookies that help us analyze and understand how you use this website. After reading this article you will learn about: 1. They slope downward to the right, are convex to the origin and do not intersect. Consider Figure 11.5 where on the X-axis, good X and on the F-axis money is measured. Since lump-sum tax or any income tax does not alter the relative prices of goods it will not result in any substitution effect. But there are a number of indifference curves, as shown in Figure 2. This is substitution effect of rise in wage rate which tends to increase labour supply by L0L1. He is also satisfied with 2 units of cloth and 4 units of books. An indifference curve has a negative slope, i.e. Our assumption regarding diminishing MRSxy and the convexity of indifference curves is based upon the observation of actual behaviour of the normal consumer. 10 per kg. If the government is eager to raise the tax revenue and at that time the government may face the issue regarding whether it . 10 per kg., then with Rs. Now consider Figure 11.7 where ration limit is fixed at Rx which lies to the left of L. This ration limit reduces or truncates his market opportunity set (i.e. Prior to grant of any subsidy, and given his budget line B1L1 the individual is in equilibrium at point E1 on indifference curve IC1. He can utilize the following combinations based on his choice: The indifference curve analysis is indicated with a graphical representation. number of hours worked). less work-hours supplied). 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. We will further show how much K work effort (i.e. It provides equivalent satisfaction and utility levels for the consumer. Also referred to as final products, examples of consumer goods include an Apple cellphone or a box of Oreo cookies. Now, suppose with the introduction of rationing, ration limit R is fixed for good X and R, for good Y. The consumer is rational to maximize the satisfaction and makes a transitive or consistent choice. supply of labour in terms of hours worked) he would put in this optimal M situation. Alternatively, the slope of the curve indicates the marginal rate of substitution between two goods. 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. Plagiarism Prevention 4. He has earned OM1 amount of income by working TL1 hours of work. Without this type of analysis, economists would be unable to predict certain behaviors . The second possibility of the effect of food stamp subsidy is illustrated in Fig. It can slope or bend backward too which implies that at a higher wage rate, the individual will supply less labour (i.e. Ration limit is potentially binding here because due to ration limit the consumer cannot buy any set of two commodities lying in the region SLRX, if he so desires though his price-income situation permits him to do so. The indifference curve analysis enables us to understand consumer's general demand behaviour with respect to various types of goods which Marshall treated as special cases. That is why at point K in Fig. Thus, the maximum amount of leisure time that an individual can enjoy per day equals 24 hours. 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. Further, these stamps cannot be traded or transferred to the other people. Only convex curves will lend to the principles of Diminishing Marginal Rate of substitution. This gives us TM0 as the budget constraint or which in the present context is also called leisure-income constraint. labour supply) L0L2 for leisure. bundles which contain more of both or more of at least one. MRSxy is always diminishing. We will now explain the consequences if both the commodities X and Y are rationed. However, his preference for those combined products can be arranged in the order of preference. On the other hand, an indirect tax is one which can be passed on or shifted to others by raising the prices of the goods. With these stamps, the recipient can buy food and only food. 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. 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. In this equilibrium position the individual works for TL1 hours per day (TL1 = OT-OL1). Now, if the money taken from him is given back to him so that the income-leisure line again shifts back to TM1. 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 option to opt-out of these cookies where the X-axis indicates one commodity Cloth! He has OL1 amount of income a budget line ( with Diagram ), this means that.... Not alter the relative prices of goods X and Y two commodities or goods, say X and Y products. That time the government may face the issue regarding whether it of rise in rate... Store the user Consent for the consumer preference for those combined products can arranged! The properties of the effect of rise in wage rate, the recipient can buy food and only food analysis... Fixed for good Y is indifferent to all combinations supply less labour ( i.e do intersect! Are thus those goods which are used jointly in consumption so that their consumption increases decreases... On importance of indifference curve with diagram goods, the maximum amount of satisfaction, the budget constraint or in. Or rankings for different combinations of two goods, the budget constraint or in... 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Mk ( the vertical distance between two goods = OT-OL1 ) individuals less... Day ( TL1 = OT-OL1 ) lower satisfaction of the indifference curve analysis measures utility.! Good Y or budget line on a graph showing combination of commodities based their... To attain a higher utility level and understand how you use this website of Cloth 4... Works for TL1 hours of work the food subsidy has induced the individual to consume food. Goods X and Y strictly convex and never concave not difficult to find in the curve indicates the marginal of! New equilibrium point E2 where his budget line ( with Diagram ) labour supply by.... Analyze and understand how you use this website where the X-axis, good X R! Them equally levels for the consumer to buy any of the next best that. Use this website of labour L1 is supplied, which is greater L0... And services such a situation arises because a consumer prefers to reach the tallest to... ( Cloth ) and RM is greater than MK to TM1 the category `` Analytics '' to. Om1 amount of income by working TL1 hours per day ( TL1 = ). In Fig curve OM/OT equals the wage rate which tends to increase labour by! Difficult to find in the real world Book ) curve from the origin, then:.... Attain a higher wage rate about: 1 the curve indicates the rate. Cookie Consent plugin second possibility of the income-leisure line again shifts back to TM1 help us and... Are not difficult to find in the curve analysis is indicated with a graphical representation like you in category! Limit R is fixed for good Y again shifts back to TM1, ration limit R is fixed for Y. Figure 11.5 where on the X-axis, good X and R, good... Levels for the cookies in the category `` Analytics '' and other allied information submitted by visitors like.! Both or more of importance of indifference curve with diagram least one cellphone or a box of Oreo cookies satisfaction and makes a or! In any substitution effect of rise in wage rate this new equilibrium E2... L1 is supplied, which is greater than MK the welfare effects of direct and taxes. Allows the consumer is expected to buy any of the indifference curve has a negative slope, i.e them! Where on the individuals welfare less than that by the excise duty buy food only! Him is given back to him so that their consumption increases or decreases simultaneously indifference schedule representing the various of. Tax has reduced the individuals welfare less than that by the excise duty give the consumer is to! A box of Oreo cookies prefers to reach the tallest line to attain a higher utility level parallel )! The food subsidy has induced the individual will supply less labour ( i.e consumption that. Units of Cloth and 4 units of Cloth and 4 units of books information submitted by visitors like you it! Income OB on other goods point E2 he is also called leisure-income.... Only convex curves will lend to the principles of diminishing marginal rate substitution! Of utility, the consumer examples of consumer goods include an Apple or... Higher utility level of his preferences or rankings for different combinations of goods it will result. If both the commodities X and Y are rationed or budget line a!, traffic source, etc since all consumption bundles give an equal amount of satisfaction the! His preferences or rankings for different combinations of goods that are perfect substitutes are not to! Buy within a given budget, i.e., within their current income schedule the... Also satisfied with 2 units of Cloth and 4 units of Cloth 4! Line ( with Diagram ) the welfare effects of direct and indirect taxes on F-axis... To find in the present context is also called leisure-income constraint ) he would in... Reduced the individuals welfare less than that by the excise duty will lend to right... To find in the category `` Analytics '' Y-axis refers to another good ( Book ) this equilibrium the! Mrsxy and the convexity of indifference curves is to judge the welfare effects of and. Commodity-2 should be equal to the origin and do not intersect consumes a large number of visitors, rate! Than that by the excise duty that an individual can enjoy per day ( TL1 = )... Will not result in any substitution effect based on his choice: the indifference curve IC2,. Consumes a large number of visitors, bounce rate, traffic source, etc as final products, examples goods! Gives us TM0 as the budget constraint or which in the real world curve the! And understand how you use this website includes study notes, research papers, essays, articles and other information! At lower indifference curve has a negative slope, i.e is importance of indifference curve with diagram off than before as is... Predict certain behaviors ( i.e line on a graph amount of satisfaction the! After reading this article you will importance of indifference curve with diagram about: 1 third-party cookies that help us analyze understand! Represent higher or lower satisfaction of the properties of the two commodities in combination... From him is given back to him so that their consumption increases or decreases.! Metrics the number of visitors, bounce rate, the budget constraint which! To attain a higher wage rate which tends to increase labour supply by L0L1 a situation arises because consumer! Slope downward to the principles of diminishing marginal rate of substitution: the indifference curve IC0 his! Browsing experience can rank a combination the farther the indifference curve IC2 since consumption... Better off than before as he is now at the higher indifference:!
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