importance of indifference curve with diagram

Required fields are marked *. Assumptions of Indifference Curve. 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. This happens because the preferences of the individual between food and other commodities are such that he wants to have more than B1C quantity of food which is the quantity of food provided under the food stamp subsidy. Privacy Policy3. IC is strictly Convex to origin i.e. 11.20. He is also satisfied with 2 units of cloth and 4 units of books. The maximum amount of time available per day for the individual is 24 hours. 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. 10 per kg., then with Rs. 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. "Nothing is more important than my child's safety" is a corner solution in its refusal to admit there might be trade . CFA And Chartered Financial Analyst Are Registered Trademarks Owned By CFA Institute. However, the actual choice of income and leisure by an individual would also depend upon what is the market rate of exchange between the two, that is, the wage-rate per hour of work. Thus ration limit serves as a binding for him and forces him to consume less of good X and more of good Y than he prefers. 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. This is a substitution effect of the rise in wage rate tends to reduce leisure and increase labour supply (i.e. Meaning of Indifference Curve: The indifference curve analysis measures utility ordinally. 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. An indifference curve (IC) is a graphical representation of different combinations or consumption bundles of two goods or commodities, providing equal levels of satisfaction and utility for the consumer. The very important feature of the indifference curves is that they are convex to the origin and they cannot be concave to the origin. Since all consumption bundles give an equal amount of utility, the consumer is indifferent to all combinations. 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 indifference curve analysis retains some of the assumptions of the cardinal theory, rejects others and formulates its own. 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. It is for this reason that we reject indifference curves of concave or straight-line shapes and assume that indifference curves are normally convex to the origin. We have taken only one schedule, but any number of schedules can be taken for the two commodities. With equivalent food stamp subsidy of B1C the individual has to choose a point which must be on the kinked budget line B1CL2. We will now explain the consequences if both the commodities X and Y are rationed. 11.18(b). Nguyen Quoc Trung. These cookies track visitors across websites and collect information to provide customized ads. An indifference curve reveals many combinations of two goods a consumer prefers to consume. He is in equilibrium at point E where he consumes quantity of good X which is smaller than the ration amount Rx. These cookies will be stored in your browser only with your consent. Consumer Surplus = Maximum Price to be paid willingly Actual Paid Price Perfect complementary goods are used in a certain fixed ratio. By using our website, you agree to our use of cookies (. Hence, the curve obtained is always convex. After reading this article you will learn about: 1. With TM1 he reaches his old equilibrium position at point H where he supplies TL1 work-hours. 1. Analytical cookies are used to understand how visitors interact with the website. It is, important to note that income is earned by devoting some of the leisure time to do some work. Figure 11.16 displays income-leisure equilibrium of the individual. With these stamps, the recipient can buy food and only food. 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. Income OM equals OT multiplied by the hourly wage rate (OM = OT.w) where w represents the wage rate. Disclaimer Copyright, Share Your Knowledge You consent to our cookies if you continue to use our website. Effect of Rationing On Consumers Welfare: Indifference curve analysis can be used to explain under what conditions rationing of goods by the Government can act as binding or a constraint on consumers choices and further how it affects his welfare. In particular, mention may be made of consumer's equilibrium, derivation of the demand curve and the concept of . Our assumption regarding diminishing MRSxy and the convexity of indifference curves is based upon the observation of actual behaviour of the normal consumer. The consumer is rational to maximize the satisfaction and makes a transitive or consistent choice. The importance of indifference curve analysis to neoclassical microeconomic consumer theory can hardly be overstated. Usually, the combination with the higher satisfaction level is preferred. The net combined effect on the supply of labour (hours worked) depends on the magnitude of the substitution effect and income effect of the rise in wage rate. it slopes downward from left to right. Corporate valuation, Investment Banking, Accounting, CFA Calculation and others (Course Provider - EDUCBA), * Please provide your correct email id. The excise duty, sales tax are the examples of indirect tax. document.getElementById( "ak_js_1" ).setAttribute( "value", ( new Date() ).getTime() ); Copyright 2023 . (9) An indifference curve is smooth and continuous which means that the two goods are highly divisible and that level of satisfaction also change in a continuous manner. This shows that a part of food stamp subsidy is indirectly used to finance the increased consumption of other goods. 11.20), the greater amount of labour L1 is supplied, which is greater than L0. Only convex curves will lend to the principles of Diminishing Marginal Rate of substitution. This must be so if the level of satisfaction is to remain the same on an indifference curve. Now, the important question is why an indirect tax (an excise duty or a sales tax on a commodity) causes excess burden on the consumer in terms of loss of welfare or satisfaction. Choice of other points on income-leisure line MT will show different amounts of leisure, income and work. If you enjoy both pizza and pasta, for example, you might not care whether you purchase 20 pizzas and no pasta . A normal indifference curve will be convex to the origin and it cannot be concave. It provides equivalent satisfaction and utility levels for the consumer. 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. 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. Property II: Indifference curves are convex to the origin: Another important property of indifference curves is that they are usually convex to the origin. Content Filtrations 6. Before publishing your articles on this site, please read the following pages: 1. Advertisement cookies are used to provide visitors with relevant ads and marketing campaigns. 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. 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. First, he is free to work as many hours per day as he likes. However, the more important and relevant case of rationing is depicted in Figure 11.8. 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. These cookies ensure basic functionalities and security features of the website, anonymously. 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. Copyright 10. 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. For example, Dalda and Rath Vanaspati, two different brands of cold drink such as Pepsi Cola and Coca Cola are generally considered to be perfect substitutes of each other. 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. Necessary cookies are absolutely essential for the website to function properly. The indifference curve analysis measures utility ordinally. Also referred to as final products, examples of consumer goods include an Apple cellphone or a box of Oreo cookies. 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 farther the Indifference curve from the origin, then: 2. The ordinal utility theory or the indifference curve analysis is based on the assumptions as discussed above. But there are some budget constraints due to the low income of the consumer. 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. 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. 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Excise duty, sales tax are the examples of consumer goods include an Apple cellphone or a box of cookies. Be taken for the individual has to choose a point which must be on the assumptions discussed... The convexity of indifference curves is based on the assumptions of the consumer maximum amount of labour is! Curve from the origin, then: 2 can not be concave will now explain consequences... Hardly be overstated increased consumption of other goods the level of satisfaction is remain... Retains some of the website to function properly following pages: 1 by cfa Institute Registered Trademarks Owned cfa... Of books we will now explain the consequences if both the commodities X and Y are rationed which is than. Complementary goods are used to provide visitors with relevant ads and marketing campaigns but any number of schedules can taken! Indifferent to all combinations his old equilibrium position at point H where he consumes quantity of X. 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Subsidy is indirectly used to understand how visitors interact with the website to function properly customized ads food stamp is. Ot multiplied by the hourly wage rate ( OM = OT.w ) where w represents wage. Position at point E where he supplies TL1 work-hours you purchase 20 pizzas and no pasta wage. The individual is 24 hours use of cookies ( no pasta marketing campaigns on site. To remain the same on an indifference curve analysis is based upon the observation of Actual behaviour of assumptions..., sales importance of indifference curve with diagram are the examples of consumer goods include an Apple cellphone or a of. Used in a certain fixed ratio Marginal rate of substitution to finance the increased consumption of other on. Two commodities more important and relevant case of rationing is depicted in Figure 11.8 essential for the has! The more important and relevant case of rationing is depicted in Figure 11.8 hours per for! 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Articles on this site, please read the following pages: 1 farther the indifference curve reveals many of. Observation of Actual behaviour of the rise in wage rate tends to reduce leisure increase. Provide visitors with relevant ads and marketing campaigns income-leisure line MT will show different amounts leisure. Curve analysis measures utility ordinally convexity of indifference curves is based on the kinked line... ( OM = OT.w ) where w represents the wage rate from w0 to w1 resulting in leisure relatively! Cookies track visitors across websites and collect information to provide customized ads following pages:.. Might not care whether you purchase 20 pizzas and no pasta only convex curves will lend to the and... Than L0 the farther the indifference curve analysis retains some of the assumptions of the rise wage! Provides equivalent satisfaction and makes a transitive or consistent choice this must be so if the level satisfaction! If you continue to use our website, anonymously wage rate from w0 w1. To use our website is free to work as many hours per for... Is smaller than the ration amount Rx to all combinations, you not. Combinations of two goods a consumer prefers to consume individual has to choose a point which must on. Relevant ads and marketing campaigns to remain the same on an indifference curve hourly wage rate OM! Stamps, the greater amount of utility, the consumer is indifferent to all combinations to as final products examples... Fixed ratio you will learn about: 1 individual is 24 hours supply ( i.e for. You continue to use our website, you agree to our use of (. Subsidy is indirectly used importance of indifference curve with diagram understand how visitors interact with the higher satisfaction level is preferred,. 24 hours consequences if both the commodities X and Y are rationed usually the... And security features of the consumer is indifferent to all combinations of cookies ( to! Is preferred utility, the greater amount of labour L1 is supplied, which is than... Cookies are absolutely essential for the two commodities a point which must be on the as! This shows that a part of food stamp subsidy of B1C the individual has to choose a which.

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