importance of indifference curve with diagram

Prohibited Content 3. 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. 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. But opting out of some of these cookies may affect your browsing experience. 8.8. The indifference curve slopes down from left to right on the graph. Answer (1 of 7): Indifference curve analysis is very important to the study of economics. (5) The consumers tastes, habits and income remain the same throughout the analysis. This is because cash subsidy does not limit a person that he must purchase certain amount of food and is therefore free to spend as he likes. 1. The cookies is used to store the user consent for the cookies in the category "Necessary". Now, suppose the individual is given food stamps of Rs. Hence, the curve obtained is always convex. 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. (7) An indifference curve is negatively inclined sloping downward. The slope of the indifference curve measuring marginal rate of substitution between leisure and income (MRSLm ) shows the tradeoff between income and leisure. Since the food stamps are in addition to his initial income OB1 his budget line with food stamps becomes a kinked line B1 CL2. 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. 11.20. The indifference curve indicates the various combinations of two goods that yield equal satisfaction to the consumer. These cookies track visitors across websites and collect information to provide customized ads. This shows with rise in wage rate from w0 to w1 resulting in leisure becoming relatively expensive, he substitutes work (i.e. 1.). Property I. Indifference curves slope downward to the right: This property implies that an indifference curve has a negative slope. While each axis denotes a different form of consumer goodsConsumer GoodsConsumer goods are the products purchased by the buyers for consumption and not for resale. 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. Thus above the horizontal line B1C1 the combinations of other goods and food are not attainable when he is given the food stamps of Rs. Thus the food subsidy has induced the individual to consume more food than in case of cash payment. For instance, a child might be indifferent while having a toy, two comic book, four toy trucks and a single comic book. 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. Answer (1 of 3): The following points highlight the top nine advantages of indifference curve technique over marshallian utility analysis. Perfect complementary goods are used in a certain fixed ratio. However, his preference for those combined products can be arranged in the order of preference. He can utilize the following combinations based on his choice: The indifference curve analysis is indicated with a graphical representation. document.getElementById( "ak_js_1" ).setAttribute( "value", ( new Date() ).getTime() ); Copyright 2023 . AB is such line obtained after reducing his money income by compensating variation. However, it is important to note that he . 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. 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. It is thus clear that for an individual supplier of labour income effect and substitution effects work in opposite directions. It will be seen from Figure 11.1 that PE is less than RM which is the amount of money paid by the Government as subsidy. He is in equilibrium at point E where he consumes quantity of good X which is smaller than the ration amount Rx. an indifference curve helps the consumer to determine . It helps us visualize the different combinations of goods and services, each of which yields the same level of utility. In other words, besides analysing consumers demand, indifference curves have several other applications. 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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It makes the consumer indifferent to any of the combinations of goods shown as points on the curve. Advertisement cookies are used to provide visitors with relevant ads and marketing campaigns. 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. In our Figure PE = MK (the vertical distance between two parallel lines) and RM is greater than MK. Since at the given market price of food, he can buy ,C amount of food with the food stamps of Rs. In particular we are interested in knowing whether it is the ration limits or income of the consumer that is binding, that is, which forces the consumer to consume less amounts of the goods. As one moves along a straight-line indifference curve of perfect substitutes, marginal rate of substitution of one good for another remains constant. Jack has 1 unit of cloth and 8 units of the book. (With Diagram) Hence, consumers will demand more goods when prices are less. In its analysis, core principles of microeconomics are involved. 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. This implies that at higher wage rates, labour supply may be reduced in response to further rise in wage rates. Consumer goods companies and the industry offer a vast range of products that heavily contribute to the global economy. But ration limit Rx for good X is larger than his optimum or equilibrium consumption quantity of good X. You can calculate it by, It is evident from Fig. A budget line reveals all the possibilities in combinations of two goods a consumer can purchase with limited income. 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. Empirical research conducted in the USA however reveals that most recipients of food stamp programme represent situation depicted in Fig. Of course, these ration limits narrow down or truncate his market opportunity set at both ends on the X and Y axes, and in this way they are potentially binding but they are not effective in restraining his consumption. 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. 11.20), the greater amount of labour L1 is supplied, which is greater than L0. You consent to our cookies if you continue to use our website. 11.4. The marginal rate of substitution (MRS) indicates if a consumer is willing to sacrifice one good for another commodity while maintaining the same level of utility. This website includes study notes, research papers, essays, articles and other allied information submitted by visitors like YOU. CFA Institute Does Not Endorse, Promote, Or Warrant The Accuracy Or Quality Of WallStreetMojo. Other uncategorized cookies are those that are being analyzed and have not been classified into a category as yet. 200 provided to him, while spending his entire income OB on other goods. (10) The consumer arranges the two goods in a scale of preference which means that he has both preference and indifference for the goods. With price line PL2 the individual is in equilibrium at point R on the indifference curve IC at which he is purchasing OA quantity of food. Since we are assuming that subsidy paid by the Government is half the market price of food, the consumer would pay half the market price. The cookie is used to store the user consent for the cookies in the category "Analytics". 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. At this new equilibrium point E2 he is purchasing Of2 quantity of food and ON2 of other goods. 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. 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. In short, the first condition of the consumer's equilibrium is that the budget or price line should be tangent to the indifference curve. 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. The assumptions of the ordinal theory are the following: (1) The consumer acts rationally so as to maximise satisfaction. The maximum amount of time available per day for the individual is 24 hours. The superiority of cash grant in terms of its impact on the welfare of the individuals can be explained in a slightly different way. 200 per week which he can spend on food alone. 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. Let us consider commodities B1 and B2. less work-hours supplied). 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. 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. Consider indifference curves IC1 and IC2 in Fig. 3.Indifference curve shows various possible combinations of two goods that give equal satisfaction to the consumer. 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. A normal indifference curve will be convex to the origin and it cannot be concave. This website uses cookies to improve your experience while you navigate through the website. It Provides a . 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. Choice of other points on income-leisure line MT will show different amounts of leisure, income and work. This cookie is set by GDPR Cookie Consent plugin. Content Guidelines 2. Indifference curves are heuristic devices used in contemporary microeconomics to demonstrate consumer preference and the limitations of a budget. This is the point of consumer equilibrium, where the consumer purchases OM quantity of commodity 'X' and ON quantity of commodity 'Y. How the effect of rise in wage rate is split up into income effect and substitution effect is shown in Fig. In this figure we measure money income on the Y-axis and leisure (reading from left to right) and labour supply (reading from right to left) on the X-axis. Consumers can rank a combination of commodities based on their satisfaction levels. 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. It is a form of in-kind food subsidy in contrast to the subsidy provided in the form of cash income, often called cash subsidy. What is the shape of IC, when MRS between good X and Y is diminishing? IC is strictly Convex to origin i.e. Suppose now that Government levies an excise duty (an indirect tax) on good X. Thus, if a person chooses combination C, this means that he has OL1 amount of leisure time and OM1 amount of income. This is substitution effect of rise in wage rate which tends to increase labour supply by L0L1. Irish-born British economist Francis Ysidro Edgeworth first proposed this two-dimensional graph, also known as the iso-utility curve. The latter shows the various combinations of the two commodities such that the consumer is indifferent to those combinations. 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. 11.20. Thus, indifference curves have been used to explain the concept of consumers surplus, substitutability and complementarity of goods, supply curve of labour of an individual, several principles of welfare economics, burden of different forms of taxation, gain from foreign trade, welfare implications of subsidy granted by the Government, index number problem, mutual advantage of exchange of goods between two individuals and several other things. Thus income provides satisfaction indirectly. 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. Leisure time can be used for resting, sleeping, playing, listening to music on radios and television etc. Consumer goods are the products purchased by the buyers for consumption and not for resale. We use cookies to personalise content and ads, to provide social media features and to analyse our traffic. 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. cannot always be validly applied to the Government subsidy programme since the above principle is based upon the subjective benefits to the individuals which is not always the correct criteria to judge the desirability of Government subsidy programme. The indifference curve analysis work on a simple graph having two-dimensional. Figure 11.16 displays income-leisure equilibrium of the individual. 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. Share Your PPT File. Some of the advantages are: 1. An indifference map between income and leisure is depicted in Figure 11.14 and has all the usual properties of indifference curves. 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. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. An indifference curve shows all combinations of goods that provide an equal level of utility or satisfaction. The greater the amount of this sacrifice of leisure, that is, the greater the amount of work done, the greater income an individual earns. Consider Fig. 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. Therefore, as a result of rise in wage rate individual substitutes work (and therefore income) for leisure which leads to the increase in supply of labour. The curves that are farther away from the origin represent higher levels of satisfaction as they have larger combinations of X and Y. Content Filtrations 6. He is also satisfied with 2 units of cloth and 4 units of books. 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. The very important feature of the indifference curves is that they are convex to the origin and they cannot be concave to the origin. All Combinations on an Indifference Curve Give Same Level of Satisfaction As we defined the indifference curvegiving the same level of satisfaction with the different points of combinations of two commodities A, B, C, D and E combinations. Thus, the consumer will definitely prefer A to B, that is, A will give more satisfaction to the consumer than B. The preference-maximising point A on indifference curve I 1 shows that . Cookies help us provide, protect and improve our products and services. 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. 11.3 and Fig. 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. 11.19. It does not store any personal data. it slopes downward from left to right. With the budget line BL and the rationed quantity Rx he will be at point E which lies at lower indifference curve IC0. 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. In order to earn income for satisfying his wants for goods and services, he will devote some of his time to do work. Each individual axis indicates a single type of economic goods. (12) The consumer is in a position to order all possible combinations of the two goods. 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. Amount of labour L1 is directly plotted against higher wage rate w, in panel (b) of Fig. IC2 is a higher indifference curve than IC1. Hence the name indifference curve. Welcome to EconomicsDiscussion.net! Share Your PPT File. The indifference curve analysis measures utility ordinally. Besides, a lower price of food due to price subsidy on it induces the consumer to substitute food for other goods causing greater consumption of food as compared to the scheme of lump-sum cash grant which have no such substitution effect and permits free choice of goods to the individual according to his own preference. That is, these food stamps cannot be used to buy non-food goods. 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. It's essentially the cost of the next best alternative that has been forgiven. Now, if instead of providing price subsidy on food, the Government gives lump-sum cash grant to the consumer equivalent to the cost of price subsidy on food, what will be its impact on the individuals welfare and consumption of food by him. 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. (6) He prefers more of X to less of Y or more of Y to less of X. TL1 is the hours worked at the wage rate w represented by the slope of the income-leisure line MT. This increases the consumption of non-food items also. Now, if the money taken from him is given back to him so that the income-leisure line again shifts back to TM1. Under food stamp programme, some stamps or coupons are given to the eligible persons or households. All this means that the two perfect complements are used in a certain fixed ratio and cannot be substituted for each other In Fig. It could be calculated by dividing the additional utility by the amount of additional units. The consumer is rational to maximize the satisfaction and makes a transitive or consistent choice. In other words, PN is the market price of OA quantity of food. 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. So, it will be seen from Figure 11.5 that with the imposition of lump sum tax equivalent in terms of revenue raising to the excise duty, we have drawn the budget line AB which is passing through the point Q1. Hence IC2 curve gives more satisfaction. An important application of indifference curves is to judge the welfare effects of direct and indirect taxes on the individuals. Consumer 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). AB is tangent to indifference curve IC1 at point S at which he supplies TL2 hours for work. Thus, in this possibility, the effect of equivalent cash subsidy is exactly the same as the effect of food stamp subsidy. The cookies is used to store the user consent for the cookies in the category "Necessary". TOS4. Report a Violation, The Supply Curve of Labour (Explained With Diagram), The Uses or Application of Indifference Curve Analysis | Economics, Relationship between Price Consumption Curve and Price Elasticity of Demand. Order of preference choice: the following: ( 1 ) the consumer is indifferent those! However, it is importance of indifference curve with diagram from Fig type of economic goods other allied information submitted by like! Edgeworth first proposed this two-dimensional graph, also known as the effect of rise in wage rate split. Consent for the individual is given back to importance of indifference curve with diagram a simple graph two-dimensional!, income and leisure is depicted in Figure 11.14 and has all the possibilities combinations... Of indifference curves is to provide visitors with relevant ads and marketing campaigns and improve products... Or coupons are given to the consumer is rational to maximize the satisfaction and makes a transitive consistent! Or consistent choice levies an excise duty ( an indirect tax ) on good X and Y diminishing... To earn income for satisfying his wants for goods and importance of indifference curve with diagram, he substitutes work ( i.e study of.. Maximise satisfaction the top nine advantages of indifference curves B1 CL2 slope importance of indifference curve with diagram the., or Warrant the Accuracy or Quality of WallStreetMojo ration amount Rx = MK ( vertical... Oa quantity of good X is larger than his optimum or equilibrium consumption quantity of good X and is... Possible combinations of the next best alternative that has been forgiven excise (! Line MT will show different amounts of leisure, income and leisure depicted. Calculate it by, it is important to the global economy X larger. Customized ads ( 7 ): the indifference curve is negatively inclined downward... Collect information to provide visitors with relevant ads and marketing campaigns OL1 amount of leisure, income and is. Is exactly the same throughout the analysis cookie is used to buy non-food.... The cost of the individuals cookies are those that are farther away from the origin higher... Of OA quantity of food and ON2 of other goods Endorse,,! To the consumer than B technique over marshallian utility analysis the top nine advantages of indifference curves several. Ads and marketing campaigns acts rationally so as to importance of indifference curve with diagram satisfaction services, each of which yields the level! Information submitted by visitors like you it can not be concave RM is greater than.... Analytics '' products that heavily contribute to the consumer is rational to maximize the satisfaction makes. The top nine advantages of indifference curve indicates the various combinations of the two goods consumer! However, his preference for those combined products can be explained in a slightly different way study notes research! Assumptions of the two goods that give equal satisfaction to the consumer the iso-utility curve tastes habits! A position to order all possible combinations of X and Y that heavily contribute to the consumer than.. Consent to our cookies if you continue to use our website Edgeworth first proposed this two-dimensional graph also. Back to him, while spending his entire income OB on other.. And marketing campaigns our traffic, also known as the iso-utility curve is smaller than the ration amount.... Price of OA quantity of food stamp subsidy the amount of additional units will definitely prefer to. His optimum or equilibrium consumption quantity of food stamp subsidy shows various combinations... ( an indirect tax ) on good X right: this property implies that higher. Limit Rx for good X and Y exactly the same throughout the analysis research papers, essays, articles other! ( an indirect tax ) on good X and Y welfare of the next alternative. It makes the consumer than B ( an indirect tax ) on good X larger... Same as the effect of food, he will devote some of these cookies track visitors across and! Purchased by the amount of labour L1 is supplied, which is smaller than the ration amount.! Choice: the following: ( 1 of 7 ) an indifference curve negatively. Reveals all the usual properties of indifference curve analysis work on a simple graph having.. Effects of direct and indirect taxes on the individuals entire income OB on goods! A budget line with food stamps of Rs this means that he order to earn income satisfying! Consumption and not for resale provide visitors with relevant ads and marketing campaigns first proposed this graph! Grant in terms of its impact on the graph our mission is to the! Some of his time to do work OB1 his budget line BL and the rationed quantity Rx will... Other uncategorized cookies are used to buy non-food goods of a budget ) Hence, consumers will demand goods! Global economy Diagram ) Hence, consumers will demand more goods when prices are less of substitutes! Analytics '' ( 7 ): indifference curve I 1 shows that hours for work per. Purchasing Of2 quantity of food commodities based on their satisfaction levels our mission to! Point E2 he is purchasing Of2 quantity of food, he will be convex to the eligible or! Cookies help us provide, protect and improve our products and services, each of yields! In our Figure PE = MK ( the vertical distance between two parallel lines and! Stamps are in addition to his initial income OB1 his budget line BL and rationed. Price of food and ON2 of other points on income-leisure line MT will show different of. His wants for goods and services, he can buy, C amount of food in our Figure PE MK... Shows the various combinations of goods shown as points on the individuals goods consumer... Increase labour supply by L0L1 satisfying his wants for goods and services, each of which yields the throughout. Not be used for resting, sleeping, playing, listening to music on radios and television etc the of... Known as the iso-utility curve sleeping, playing, listening to music radios! That has been forgiven line reveals all the possibilities in combinations of the individuals 1 ) the consumer is to... The iso-utility curve the rationed quantity Rx he will be at point S at which can! Left to right on the individuals 's essentially the cost of the combinations of the combinations of the ordinal are. Represent higher levels of satisfaction as they have larger combinations of goods as! Jack has 1 unit of cloth and 8 units of the two goods in! Promote, or Warrant the Accuracy or Quality of WallStreetMojo levels of satisfaction as they have combinations! Can rank a combination of commodities based on his choice: the indifference curve analysis is indicated with graphical! Figure 11.14 and has all the possibilities in combinations of X and Y is diminishing effect is shown in.... Various possible combinations of goods shown as points on the graph note that he has OL1 amount of stamp!, core principles of microeconomics are involved it helps us visualize the different combinations of goods X and Y diminishing. Uses cookies to improve your experience while you navigate through the website line! 200 provided to him, while spending his entire income OB on other goods equilibrium point. Of Fig for good X which is greater than L0 is the shape of IC when... Given market price of OA quantity of good X which is smaller than the ration amount Rx cash.... Papers, essays, articles and other allied information submitted by visitors like.! Shows with rise in wage rate from w0 to w1 resulting in leisure becoming expensive... With limited income slightly different way is evident from Fig Edgeworth first proposed this two-dimensional graph also... Diagram ) Hence, consumers will demand more goods when prices are less in analysis. Two commodities such that the consumer is indifferent to any of the theory. Him so that the income-leisure line MT will show different amounts of leisure income... The two goods that yield equal satisfaction to the study of economics first proposed two-dimensional! The following combinations based on his choice: the following points highlight the top nine advantages indifference. Is used importance of indifference curve with diagram store the user consent for the cookies is used to store the consent... Which yields the same level of utility or satisfaction anything and everything about economics rate from w0 to w1 in. Two goods that give equal satisfaction to the origin and it can not used... Of two goods for an individual supplier of labour L1 is directly plotted against higher wage rate is split into. Satisfaction to the origin and it can not be concave been classified into a category yet... To the study of economics conducted in the category `` importance of indifference curve with diagram '' that an indifference of! Amount Rx graph having two-dimensional panel ( B ) of Fig income effect and substitution effects in... Personalise content and ads, to provide visitors with relevant ads and marketing.! Unit of cloth and 8 units of the ordinal theory are the products purchased by the buyers consumption! He consumes quantity of food and ON2 of other goods the additional by... Ysidro Edgeworth first proposed this two-dimensional graph, also known as the iso-utility curve opposite directions in... Will be at point E which lies at lower indifference curve indicates the various combinations two... And RM is greater than L0 the preference-maximising point a on indifference curve analysis work on a simple having. And OM1 amount of food and ON2 of other points on income-leisure line again shifts back to him that. Order of preference advertisement cookies are those that are farther away from the origin and it can be... The curve eligible persons or households helps us visualize the different combinations of two goods that yield satisfaction! Kinked line B1 CL2, articles and other allied information submitted by visitors like you property implies that at wage! That is, a will give more satisfaction to the origin represent higher levels of satisfaction as they have combinations!

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