They may represent higher or lower satisfaction of the consumer. 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. IC2 is the higher indifference curve than IC1. 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. If now the Government introduces a rationing for commodity X and fixes a ration of X equal to ORx (At point Rx we have shown a vertical line showing the constraint or ration limit imposed by the rationing fixed at ORx). A budget line reveals all the possibilities in combinations of two goods a consumer can purchase with limited income. This is quite evident from panel (b) of Fig. This website uses cookies to improve your experience while you navigate through the website. (8) An indifference curve is always convex to the origin. The cookies is used to store the user consent for the cookies in the category "Necessary". 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. Several kinds of subsidies are paid to the individuals these days by the Government for promoting welfare of the people. This means for most of the recipients, food stamp programme has the same effect as a cash subsidy. In other words, the indifference curve is relatively flatter in its right-hand portion and relatively steeper in its left-hand portion. Meaning of Indifference Curve: The indifference curve analysis measures utility ordinally. 4 Important Properties of Indifference Curve (with curve diagram) - - StuDocu. 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. Other uncategorized cookies are those that are being analyzed and have not been classified into a category as yet. This is depicted in Figure 11.17 where at the equilibrium point E a steeper leisure-income line EK than MT has been drawn. This supply of labour is directly shown against wage rate w0 in panel (b) of Figure 11.18. The very important feature of the indifference curves is that they are convex to the origin and they cannot be concave to the origin. 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. This cookie is set by GDPR Cookie Consent plugin. Share Your Word File With the given wage rate, the individual will choose a combination of income and leisure lying on the income-leisure line MT that maximises his satisfaction. The excise duty, sales tax are the examples of indirect tax. One possibility is that with the food-stamp subsidy and resultant kinked budget line B1CL2, 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. 8.8 two perfect complements are consumed in the ratio, 3X: 27. Introduction of rationing limits forces him to come to point K on the lower indifference curve IC0 and consume less amounts of both the goods than he would do without the restriction of rationing. It follows that PE is less than RM. 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. 200 provided to him, while spending his entire income OB on other goods. You consent to our cookies if you continue to use our website. It is the income that serves as a binding on his consumption choice and not the ration limit. 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. By using our website, you agree to our use of cookies (. Thus, with the rise in wage rate, supply of labour has decreased by L0L1. 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. Assumes marginal rate of substitution to diminish. 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. (4) The prices of the two goods are given. It provides equivalent satisfaction and utility levels for the consumer. Hence IC2 curve gives more satisfaction. This cookie is set by GDPR Cookie Consent plugin. he always prefers larger bundle as it gives him higher satisfaction. 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. If indifference curves were concave or straight lines, the consumer would succumb to monomania, that is, he would buy and consume only one good. 11.19 that income effect is stronger than substitution effect so that the net result is reduction in labour supply by L0L1 work-hours. In particular, mention may be made of consumer's equilibrium, derivation of the demand curve and the concept of . This is directly plotted against the wage rate w0 in panel (b) of Fig. This property of indifference curves follows from assumption 3, which is that the marginal rate of substitution of X for Y (MRSxy) diminishes as more and more of X is substituted for Y. We know that consumers in actual world do not generally buy and consume one good. 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. The utility is expressed in terms of ordinal numbers. We use cookies to personalise content and ads, to provide social media features and to analyse our traffic. Let us take the case of food subsidy which is given by the Government to help the needy families. Thus, in this possibility, the effect of equivalent cash subsidy is exactly the same as the effect of food stamp subsidy. Welcome to EconomicsDiscussion.net! Share Your PPT File. Other uncategorized cookies are those that are being analyzed and have not been classified into a category as yet. Here, we understand that all three products resting in the indifferent curve give him the same satisfaction. With the imposition of lump sum tax, the price line will shift below but will be parallel to the original price line PL1. Analytical cookies are used to understand how visitors interact with the website. It follows therefore that for good K ration limit is actually binding as it forces the consumer to point K on a lower indifference curve IC0 than optimum point E on indifference curve IC, at which he would have been without the restriction of rationing. It means that if combination A is preferable to B, and to C, then A is preferable to C. Similarly, if the consumer is indifferent between combinations A and B, and and C, then he is indifferent between A and C. This is an important assumption for making consistent choices among a large number of combinations. The consumer behavior remains constant in the analysis. The shaded region bounded by the budget line BL and the coordinate axes represents market opportunity set from which the consumer can make a choice of the two commodities. 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.. 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. Consumer Surplus = Maximum Price to be paid willingly Actual Paid Price. 1.). Microeconomics is a bottom-up approach where patterns from everyday life are pieced together to correlate demand and supply. Under price or excise subsidy the Government pays a part of the price of a good and allows the consumer to buy as many units of the good as he desires at the sub-sidised price. In the United States it was introduced in 1964 and was amended in 1979 and since then it continues there in the amended form. 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. Complements are thus those goods which are used jointly in consumption so that their consumption increases or decreases simultaneously. When no price subsidy is paid, the individual faces the price line PL1. Each individual axis indicates a single type of economic goods. Share Your Word File Another point which is worth mentioning in this regard is that indifference curves cannot even meet or touch each other or be tangent to each other at a point. 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. The indifference curve analysis work on a simple graph having two-dimensional. To break up this wage effect on labour supply, we reduce his money income by compensating variation in income. 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. 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. 200 he can buy 20 kg of food. We therefore conclude that indifference curves cannot cut each other. It will be interesting to know why there is need for paying higher wage rate than the normal wage rate for getting more or overtime work from the individuals. Consider Figure 11.5 where on the X-axis, good X and on the F-axis money is measured. This is because food and other goods are here considered as normal goods whose quantity demanded increase with the increase in income. Combination Q on the higher indifference curve IC2 will give a consumer more satisfaction than combination S on the lower indifference curves IC1 because the combination Q contains more of both goods X and Y than the combination S. Hence the consumer must prefer Q to S. And by transitivity assumption, he will prefer any other combination such as combination R on IC2 (all of which are indifferent with Q) to any combination on IC1 (all of which are indifferent with S) We, therefore, conclude that a higher indifference curve represents a higher level of satisfaction and combinations on it will be preferred to the combinations on a lower indifference curve. This website includes study notes, research papers, essays, articles and other allied information submitted by visitors like YOU. In this case, therefore, B1C, will be equal to 20 kg. We cannot predict the specific result purely on theoretical grounds. 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. But the two indifference curves cutting each other lead us to an absurd conclusion of A being equal to Bin terms of satisfaction. It will be observed that binding by rationing lowers his level of welfare as he is forced to come to the point L on a lower indifference IC0 where he consumes less of good Y and more of good X than he prefers. It helps us visualize the different combinations of goods and services, each of which yields the same level of utility. Lump-sum tax has reduced the individuals welfare less than that by the excise duty. An indifference curve is the locus of all those combinations of two goods that yields the same level of utility (satisfaction) to the consumer so that the consumer is indifferent to purchase the particular combination s/he selects. . The farther the Indifference curve from the origin, then: 2. 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. However, such a situation is relevant in case of a poor family whose income is so small that it cannot buy even the rationed quantity. To do so we take away so much income from the individual that he comes back to the original indifference curve IC1.
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