We will also demonstrate how the effect of food-stamp subsidy differs from cash subsidy. An Indifference curve shows potential combinations of two items or commodities that, when bought in any order along the curve, leave the buyer equally well off or satisfied. Therefore, RM is also greater than PE. With these stamps, the recipient can buy food and only food. Other uncategorized cookies are those that are being analyzed and have not been classified into a category as yet. This is substitution effect of rise in wage rate which tends to increase labour supply by L0L1. That is, income is earned by sacrificing some leisure. 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. It is important to note that leisure is a normal commodity which means that increase in income leads to the increase in leisure enjoyed (i.e. Also, it means the consumer cannot prefer one bundle over another on the same graph. 8.6. With given income of the consumer and prices of the two goods we draw a budget line BL in Figure 11.6. Hence, the curve obtained is always convex. This trade-off means how much income the individual is willing to accept for one hour sacrifice of leisure time. This website includes study notes, research papers, essays, articles and other allied information submitted by visitors like YOU. Thus income provides satisfaction indirectly. To do so we take away so much income from the individual that he comes back to the original indifference curve IC1. 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. . If the purpose is to increase the consumption of food and therefore provide adequate diet to the people, then food stamp subsidy is better than cash subsidy as under the former, the individual is constrained to buy at least a given quantity of food. Thus, in this case, rationing is actually binding for the consumer and reduces his welfare. 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. Further, he is better off than before as he is now at the higher indifference curve IC2. Suppose further that price of food is Rs. Answer (1 of 3): The following points highlight the top nine advantages of indifference curve technique over marshallian utility analysis. 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. These combinations provide the same level of satisfaction and utility to the consumer. Figure 11.11 depicts the case of a relatively rich person who without the binding of rationing is at point E on indifference curves IC1 and is consuming greater quantities of the two goods than the ration amounts. Before publishing your Articles on this site, please read the following pages: 1. (7) An indifference curve is negatively inclined sloping downward. But opting out of some of these cookies may affect your browsing experience. (say apples), quantity of another good (say oranges) must fall so that the total satisfaction (utility) remains same. 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. Combination Q has been taken on a higher indifference curve IC2 and combination S on a lower indifference curve IC1. In this case with cash subsidy the individual spends more than his initial income OB1 on other goods. Indifference curve analysis can be used to explain an individuals choice between income and leisure and to show why a higher overtime wage rate must be paid if more hours of work are to be obtained from the workers. IC2 is a higher indifference curve than IC1. Choice of other points on income-leisure line MT will show different amounts of leisure, income and work. 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. This is because some part of the income which the individual was spending on food prior to food-stamp subsidy gets released because of the food-stamps being used for its purchase and this released income is spent on non-food items. Since lump-sum tax or any income tax does not alter the relative prices of goods it will not result in any substitution effect. TOS4. It comprises individual choices, marginal utilityMarginal UtilityA customer's marginal utility is the satisfaction or benefit derived from one additional unit of product consumed. In other words, the indifference curve is relatively flatter in its right-hand portion and relatively steeper in its left-hand portion. 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. The consumer is rational to maximize the satisfaction and makes a transitive or consistent choice. 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. Now, if substitution effect had been larger than income effect, work-hours supplied would have increased as a result of rise in wage rate. It is the locus of points representing pairs of quantities between which the individual is indifferent, so it is termed an indifference curve. It is, in fact, an iso-utility curve showing equal satisfaction at all its points. 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. It explains consumer behaviour in terms of his preferences or rankings for different combinations of two goods, say X and Y. 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. 11.20. 11.3 the individual maximises his satisfaction at point E2 where his budget line is tangent to indifference curve IC2. work- hours) slopes upward and under what circumstances it bends backward can be explained in terms of income effect and substitution effect of a change in wage rate. Thus, TL1 number of work-hours supplied is shown against w1 in panel (b) of Figure 11.18. The below diagram shows an indifference map with three indifference curves. 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. It will be seen from Figure 11.2 that with food subsidy RM, the individual is having OA amount of food, whereas with equivalent cash payment of PC the individual purchases OB amount of food which is less than OA. Authorized users may be able to access the full text articles at this site. Privacy Policy3. This cookie is set by GDPR Cookie Consent plugin. The cookie is set by GDPR cookie consent to record the user consent for the cookies in the category "Functional". The use of the indifference curve will help to judge the welfare effect of direct and indirect taxes on the individuals. He now works for TL2 hours per day, TL1 at hourly wage rate w and L1L2 at higher wage rate w. Your email address will not be published. Indifference curves are heuristic devices used in contemporary microeconomics to demonstrate consumer preference and the limitations of a budget. Some of the important problems are explained below with the help of this technique. Assumptions of Indifference Curve. This is an important feature of an indifference curve. 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. 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. In this optimal situation, income- leisure trade off (i.e. Income OM equals OT multiplied by the hourly wage rate (OM = OT.w) where w represents the wage rate. The indifference curve indicates the various combinations of two goods that yield equal satisfaction to the consumer. Since the consumer cannot use food stamps to buy non-food items (other goods) he cannot spend more than his initial income OB1 on other goods. Answer (1 of 7): Indifference curve analysis is very important to the study of economics. This website includes study notes, research papers, essays, articles and other allied information submitted by visitors like YOU. Thus the trade-off between income and leisure at this point is M/L. 11.4 . The loss of satisfaction to the consumer on account of the downward movement must be made up by the gain through the rightward movement. Meaning of Indifference Curve: The indifference curve analysis measures utility ordinally. It shows the consumers preference for one good over another only if it is equally satisfying. This website uses cookies to improve your experience while you navigate through the website. The maximum amount of time available per day for the individual is 24 hours. 4 Important Properties of Indifference Curve (with curve diagram) - - StuDocu. Prior to grant of any subsidy, and given his budget line B1L1 the individual is in equilibrium at point E1 on indifference curve IC1. 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. It explains consumer behaviour in terms of his preferences or rankings for different combinations of two goods, say X and Y. 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. 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. Each individual axis indicates a single type of economic goods. This website uses cookies to improve your experience while you navigate through the website. 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. It provides equivalent satisfaction and utility levels for the consumer. 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 slope of the curve at any given point represents utility for any combination of two goods. Further, as will be seen from Figure 11.2, with a cash grant the individual buys less food and more of other goods relative to the situation under price subsidy with the equivalent monetary cost. 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). 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. 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. 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. But the two indifference curves cutting each other lead us to an absurd conclusion of A being equal to Bin terms of satisfaction. In other words, a consumer is considered indifferent between any two bundles indicated by a point on the curve, provided these combinations give the same utility. But opting out of some of these cookies may affect your browsing experience. Thus, to quote Prof. Watson again, you can make someone happier if you give him cash instead of a commodity, even if the commodity is something he wants. We will further show how much K work effort (i.e. 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 derivation of supply curve of labour is depicted in 11.18. Prohibited Content 3. In this equilibrium position the individual works for TL1 hours per day (TL1 = OT-OL1). 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. The cookie is used to store the user consent for the cookies in the category "Performance". 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. When the consumer repeatedly substitutes or consumes one good over another, the marginal rate of substitution diminishes. supply of labour in terms of hours worked) he would put in this optimal M situation. For instance, if price of food is Rs. Share Your PDF File At different income-leisure levels, the trade-off between leisure and income varies. Content Guidelines 2. Privacy Policy 8. 1., that is, price of rupee one is Re. 10 per kg., then with Rs. A glance at panel (b) of Figure 11.18 will reveal that supply curve of labour is upward sloping indicating positive response of the individual to the rise in wage rate. 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. CFA And Chartered Financial Analyst Are Registered Trademarks Owned By CFA Institute. TOS4. That is, at wage rate w0he supplies TL0 amount of labour. 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. Welcome to EconomicsDiscussion.net! 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. read more, theory of exchange, etc. Meaning of Indifference Curve 2. Since A is on a higher . 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. Until the early 20th century, economists had been unable to provide a . This means that a part of food stamp subsidy has been indirectly used for financing the purchases of non-food commodities. Usually, the combination with the higher satisfaction level is preferred. Under what conditions supply curve of labour (i.e. Since all the combinations give the same amount of satisfaction, the consumer prefers them equally. Budget Line: Notes on Budget Line, Space, Changes and Slope. It may, however, be noted that on theoretical grounds it cannot be predicted which effect will be stronger. Thus, he has worked for TL1 hours to earn OM1 amount of income. The indifference curve slopes down from left to right on the graph. 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. This is a substitution effect of the rise in wage rate tends to reduce leisure and increase labour supply (i.e. 11.20. Since the consumer gets an equal preference for all bundles of goods, they are indifferent about any two combinations on the curve. Only a convex indifference curve can mean a diminishing marginal rate of substitution of X for K If indifference curve was concave to the origin it would imply that the marginal rate of substitution of X for y increased as more and more of X was substituted, for Y. How the effect of rise in wage rate is split up into income effect and substitution effect is shown in Fig. The budget line is tangent to indifference curve IC2 at point 'E'. This implies that at higher wage rates, labour supply may be reduced in response to further rise in wage rates. 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. It will be seen from Figure 11.9 that ration amounts of Rx and Ry of goods X and Y respectively are greater than OM and ON which the consumer is buying with his price-income situation. 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. When no price subsidy is paid, the individual faces the price line PL1. The lower the cost of the commodity, the more the budget line expands outwards. It helps us visualize the different combinations of goods and services, each of which yields the same level of utility. 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). At the old price (before the excise duty was imposed), he could purchase ON quantity of good X for PT amount of money. Before publishing your articles on this site, please read the following pages: 1. GCD210267, Watts and Zimmerman (1990) Positive Accounting Theory A Ten Year Perspective The Accounting Review, Subhan Group - Research paper based on calculation of faults, Density function, CDF, and final offer arbitration game, CFA Inst - Risk Profiling through a Behavioral Finance Lens. This cookie is set by GDPR Cookie Consent plugin. However, the more important and relevant case of rationing is depicted in Figure 11.8. 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. Supply curve of labour shows how an individuals work effort responds to changes in the wage rate. In other words, to increase leisure by one hour, an individual has to forego the opportunity of earning income (equal to wage per hour) which he can earn by doing work for an hour. 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. "Nothing is more important than my child's safety" is a corner solution in its refusal to admit there might be trade . 1. Login details for this Free course will be emailed to you. 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. AB is tangent to indifference curve IC1 at point S at which he supplies TL2 hours for work. Advertisement cookies are used to provide visitors with relevant ads and marketing campaigns. 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. 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.
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