3. Suppose there is a change in his preferences. Prohibited Content 3. 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. Use diagrams solely for applicable questions and now not in each answer. The new equilibrium of the consumer is on IC1 which is higher than the IC. They are used to analyze consumer preferences and a number of other concepts. This is a substitution effect of the rise in wage rate tends to reduce leisure and increase labour supply (i.e. At this new equilibrium point E2 he is purchasing Of2 quantity of food and ON2 of other goods. Although only three indifference curves are shown in Figure 7.11 "Indifference Curves", in principle an infinite number could be drawn. The very important feature of the indifference curves is that they are convex to the origin and they cannot be concave to the origin. 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. Report a Violation 11. The supply curve of labour can be drawn from the locus of the equilibrium points E1E2 and But the wage-offer curve is not the supply curve of labour. To derive the supply curve of labour from the wage-offer curve given in Figure 12.32, we draw the wage-hour schedule in Table 12.6. 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. 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. An image or graph can say more. This is quite evident from panel (b) of Fig. It is a graph that gives a consumer equal satisfaction, making the consumer indifferent. In the figure above, there are three indifference curves, Viz. Found inside – Page 33This understanding has huge importance in human resource management. ... In such cases we get indifference curves, which are concave to the origin. This means that up to a point substitution effect is stronger than income effect so that labour supply curve slopes upward, but beyond that at higher wage rates supply curve of labour bends backward. This increases the consumption of non-food items also. Consumer is in equilibrium at IC at point B1 buying OX units of commodity X and spending AA2 money income. Empirical research conducted in the USA however reveals that most recipients of food stamp programme represent situation depicted in Fig. That is, income effect of the rise in wage rate on leisure is positive, that is, leads to the increase in the hours of leisure enjoyed (that is, tends to decrease labour supply). Found inside – Page 247Indifference Curve Sender's Ideal Point Initial Issue The shape of the indifference curves reflects the importance each. Figure 11–1. The Logic of Linkage. 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. The indifference curve IC3 shows greater amount of satisfaction and it contains more of both goods than IC2 and IC1 (IC3 > IC2 > IC1). They Slope Negatively or Slope Downwards from the Left to the Right: This is an important feature of Indifference Curve. It is thus clear that for an individual supplier of labour income effect and substitution effects work in opposite directions. (b) If a parent did not receive a subsidy, would they still have a preference for the type of subsidy the government pays? In the given diagram, we can see IC1, IC2 and IC3 are three different indifference curves and AB is a budget line. 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. Whereas income effect of the rise in wage rate tends to reduce supply of labour, substitution effect tends to increase it. This is directly plotted against the wage rate w0 in panel (b) of Fig. They can reach this level only by mutual agreement otherwise the point of exchange depends upon the bargaining power of each party. less work-hours supplied). The importance of indifference curve analysis to neoclassical microeconomic consumer theory can hardly be overstated. the concept of a national well-being or happiness is poorly defined. For example, Figure 1 presents three indifference curves that represent Lilly's preferences for the tradeoffs that she faces in her two main relaxation activities: eating doughnuts and reading paperback books. goods other than food). This position is represented by point E where the curve I1a intersects I1b. The full market price of OB cereals is MD on the line MN where the curve lo touches. At this point, both the necessary condition and the supplementary condition get fulfilled, and . Therefore, RM is also greater than PE. Chris's Wage: $10/hr. As explained above in Fig. For instance, the aim of Government’s food subsidy programme may be that the needy families should consume more food so that their health and efficiency may be improved. This supply of labour is directly shown against wage rate w0 in panel (b) of Figure 11.18. community indifference curves are inconvenient and difficult to use. This implies that at higher wage rates, labour supply may be reduced in response to further rise in wage rates. 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. But when he is already supplying a large amount of labour and earning sufficient income, further increases in wage rate may induce the individual to demand more leisure so that income effect may outweigh the substitution effect at higher wage rates. In the given diagram, we can see IC1, IC2 and IC3 are three different indifference curves and AB is a budget line. 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. Thus, food stamps subsidy has led him to buy not only more food but also more of other goods. It is a curve that shows the combination of goods which gives the same level of satisfaction to the consumers so that an individual is indifferent. The curve obtained by joining optimal consumption combinations such as e 1, e and e 2 is called the price consumption curve (PCC). We take two consumers A and В who possess two goods X and Y in fixed quantities respectively. It is further assumed that he will continue to buy the commodity even after the imposition of the duty when its price goes up. Thus SC is the amount of tax which he pay for it. After an increase in the price of good 1, the consumer moves to point 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. In the box diagram, Figure 12.28, Оa is the origin for consumer A and Оb the origin for consumer В (turn the diagram upside down for understanding). Such a situation arises because a consumer consumes a large number of goods and services. Since the food stamps are in addition to his initial income OB1 his budget line with food stamps becomes a kinked line B1 CL2. the derivation of community indifference curves from those of individuals is unclear. He is in equilibrium at point E where he consumes quantity of good X which is smaller than the ration amount Rx. (3) Indifference Curve are Convex to the Origin:This is an . According to the first system of rationing, both consumers A and В are given equal specific quantities of rice and wheat, OR + OW. But the curve I 2 I 2 represents a higher level of public welfare than the curve I 1 I 1 , and the curve I 3 I 3 still higher welfare than I 2 I 2 curve. But, still it is criticised by many economists due to some unrealistic assumptions, it is based upon. If his preference for the present goods increases, his price-income line will move to P1F so that he is in equilibrium at point Q on I1 He now buys OA, present goods and thus saves less for the future goods. will work for less hours). When he is given subsidy by supplying cereals at a lower price, his price-income line is MP (it is equivalent to a fall in the price of cereals). Hence, difference between AA2 and AA1 is the consumer’s surplus. This is substitution effect of rise in wage rate which tends to increase labour supply by L0L1. This approach has various applications and importance in economic analysis as given below: The indifference curve approach is used in the theory of consumer behaviour and helps each consumer in maximisation of his satisfaction which is his ultimate and basic objective. With the introduction of the liberal scheme each can have more or less of rice or wheat according to his taste. Therefore, with subsidy the individual will face the price line PL2 where OL1 = L1 L2. We will further show how much K work effort (i.e. Sammy's New Wage: $20/hr. It will be seen that with ration limit fixed at ORx rationing does not act as a binding at all and prove to be quite ineffective in restricting the consumption of good X which is the objective of the policy. 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. Provides a rich array of over 100 examples that show how theory works in real companies, industry, and government. * Applications throughout the book and in four unique applications chapters demonstrate the importance of microeconomics to ... 11.19. This condition of exchange will be satisfied at a point where the indifference curves of both the exchangers touch each other. Prohibited Content 3. At the old price (before the excise duty was imposed), he could purchase ON quantity of good X for PT amount of money. 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. Baumol has taken three main assumptions of non-satiety, transitivity and diminishing marginal rate of substitution. As a result, the purchase of the future goods will fall from OB to OB1. The approach of the indifference curve is based on ordinal utility in. 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. The analysis of an indifference curve can be carried out on a simple two-dimensional graph. That is, income is earned by sacrificing some leisure. A line CC passing through these points is the “contract curve” or the “conflict curve”, which shows the various positions of exchange of X and Y that equalise the marginal rates of substitution of the two exchangers. The maximum amount of time available per day for the individual is 24 hours. Figure: Interplay of budget line and indifference curves. When the worker is in equilibrium at the tangency point E1 of wage line W1L and indifference curve I1, he earns E1L1 wage by working L1L hours and enjoys OL1 of leisure. Until the early 20th century, economists had been unable to provide a. The various assumptions of the analysis are explained below. Zinzi has a talent for finding lost things. So they represent negative utility. (a) Non Satiety: This assumption implies that the consumer has not reached the point of […] Now he can have ORb of rice + OWa of wheat. Use diagrams appropriately. Article shared by. Image Courtesy : img.docstoccdn.com/thumb/orig/69013971.png. Thus, as compared to the situation prior to food-stamp subsidy, he is on higher indifference curve showing a greater level of satisfaction or welfare and consuming greater quantities of food and other goods. supply of labour in terms of hours worked) he would put in this optimal M situation. In Figure 12.36 the money income of the taxpayer is shown along the vertical axis. The equivalent variation MR shows that in the absence of the subsidy, a cash payment would bring the consumer on the same indifference curve, which makes him as better off as the subsidy. The line connecting the points E1E2 and E3 is called the wage-offer curve. In Figure 12.29 at the equilibrium point C, he buys OA of cereals which are less than OB when he was getting them at the subsidised price. This type of analysis draws on the use of indifference curve analysis and consumer preferences to analyze trading outcomes. 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. An indifference map between income and leisure is depicted in Figure 11.14 and has all the usual properties of indifference curves. Consumption at this point is 11 units of good 1 and 8 units of good 2. It can be studied with the help of indifference curves. In other words, PN is the market price of OA quantity of food. At this price-income line, he is in equilibrium at point E on curve I1 where he buys OB of cereals by spending MS amount of money. 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. 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 diagram 3.11, there are three indifference curves IC 1, IC 2 and IC 3. But after rationing he is at equilibrium on E1 point of IC1 where he was OQx1 of commodity X and saves money OY2. 1., that is, price of rupee one is Re. In microeconomics, indifference curve is an important tool of analysis in the study of consumer behavior. It is designed for a relatively sophisticated undergraduate who has not taken a basic university course in economics. The book can easily serve as an intermediate microeconomics text. The focus of this book is on the conceptual tools. In our example, the consumer yields 250 utils. [12] (b) Discuss, using indifference curve analysis, how the impact of an increase in indirect taxation on the quantity demanded of a good depends on whether it is a normal or inferior good. The supply curve of an individual worker can also be derived with the indifference curve technique. 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. Thus, the maximum amount of leisure time that an individual can enjoy per day equals 24 hours. Similarly, when his wage increases, to L1, he works for longer hours L2 L and with E3 L3 wage increase, he works for still longer hours L3 L and enjoys lesser and lesser leisure than before. Indifference curve technique can also be used in the theory of exchange wherein both buyers and sellers exchange commodities. Account Disable 12. In the theory of production: The basic aim of a producer is to attain a low cost combination. But ration limit Rx for good X is larger than his optimum or equilibrium consumption quantity of good X. We take a situation when the subsidy is not paid in money but the consumers are supplied cereals at concessional rates, the price-difference being paid by the government. The indifference curve technique helps in considering the welfare implications of income tax vs. excise duty or sales tax. The Uses or Application of Indifference Curve Analysis! 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. indifference curve (it need not be exactly to scale, but it needs to reflect accurately whether there is a diminishing MRS x, y). Consumer is in equilibrium at point E on IC and he purchases OY1 of commodity Y and OQx of commodity X. Meaning of Indifference Curve 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. English economist Edgeworth used this tool for the first time and for which box- diagram technique and contract curve were used to identify the balance exchange rate between two persons. We shall explain below only few applications. Therefore, the ration limits in this case are not actually binding since these do not any more constrain his consumption. Edit this Diagram. 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 individual’s welfare and consumption of food by him. He now works for TL2 hours per day, TL1 at hourly wage rate w and L1L2 at higher wage rate w’. Taking the substitution effect and the income effect of the wage increase up to the wage rate W2, the substitution effect is stronger than the income effect. Individual A would, however, be at a disadvantage for he is on the lowest indifference curve I1a. W.J. But given the preferences of the individual between food and other goods, he is in equilibrium at the same point E2 at which his budget line B2L2 is target to the indifference curve IC2. Indifference curve approach is free from all the criticism levelled against cardinal approach or utility analysis as developed by Professor Alfred Marshall. Before publishing your articles on this site, please read the following pages: 1. Thus in this case rationing is actually binding on him and reduces his welfare. 11.3 where along the X-axis we measure quantity of food and along the F-axis we measure money which represents all other goods, (i.e. Some amount of good 2 can compensate for Bad 1 14 Satiation Another example of non-monotonic preferences 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. 11.18(b). The price line PT is tangent to the indifference curve IC 2 at point C. The consumer gets the maximum satisfaction or is in equilibrium at point C by purchasing OE units of good Y and OH units of good X with the given money income. Privacy Policy 8. Now, suppose the individual is given food stamps of Rs. if each is in a position to move to a higher indifference curve. Each axis indicates a specific type of product. Image Guidelines 5. Therefore, this can be interpreted to be the case of a poor family whose optimum consumption basket of the two goods is small because of its low income and therefore remains unaffected if ration limits are set at higher levels. With the help of indifference curve technique the problem of exchange between two individuals can be discussed. Therefore, in economics leisure is regarded as a normal commodity the enjoyment of which yields satisfaction to the individual. 11.20), the greater amount of labour L1 is supplied, which is greater than L0. monopo. 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). It shows that the consumer successively moves on a higher indifference curve and becomes better off, with a fall in the price of good X (P X). 200 provided to him, while spending his entire income OB on other goods. TL1 is the hours worked at the wage rate w’ represented by the slope of the income-leisure line MT. 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. The indifference curves are concave to the origin because if the authorities want to reduce unemployment, they must have higher inflation and vice-versa. An indifference map is a family or collection or set of indifference curves corresponding to different levels of satisfaction. Given the price of the present and future goods, the income of the consumer, his tastes and preferences for the present and the future, and the rate of interest, he buys OA of the present goods and plans to save so much as to have OB of goods in the future. The only introductory economics text to equip students to address today's pressing problems by mastering the conceptual and quantitative tools of contemporary economics. If exchange were to take place at point P then consumer S would be in an advantageous position because he is on the highest indifference curve I3b. Now, consider Figure 11.10 where it will be seen that ration limit Ry is smaller than consumer’s 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. An individual’s decision to save depends upon his present and future income, his tastes and preferences for present and future commodities, their expected prices, on the current and future rate of interest, and on the stock of his savings. Further, income is used to purchase goods, other than leisure for consumption. If excise duty is levied in place of income tax then the consumer’s budget line will shift downward to AB2 and the consumer will be in equilibrium at E2 point with the amount of OQX2 of commodity X. OQx2 is lesser than OQX1. 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. The diagram shows that units of labour and capital are shown on OX-axis and OY-axis respectively. W2L is the wage line or income-leisure line whose slope indicates wage rate (w) per hour. But the consumer receives cereals at a lower price. This appendix presents an alternative approach to describing personal preferences, called indifference curves, which avoids any need for using numbers to measure utility. The individual’s 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. “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. 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. The main attributes or properties or characteristics of indifference curves are as follows: (1) Indifference Curves are Negatively Sloped: The indifference curves must slope down from left to right. Indifference curve technique can also be used in the theory of exchange wherein both buyers and sellers exchange commodities. tap diagram to zoom and pan. Suppose the initial budget line is AB in the base period 0 and the consumer is in equilibrium at point P on the indifference curve Io in Figure 12.31. 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. Whether an income tax hurts the tax payer more or an excise duty of an equal amount? If price of a commodity falls, the quantity demanded of it will rise and vice versa. In panel (a) on joining points Q, R and S we get what is often called wage-offer curve which is similar to price-consumption curve. Each point on an indifference curve represents a consumption bundle, and the consumer is indifferent among all consumption bundles on the indifference curve. That is, these food stamps cannot be used to buy non-food goods. This is depicted in Figure 11.17 where at the equilibrium point E a steeper leisure-income line EK than MT has been drawn. The above diagram shows the U indifference curve showing bundles of goods A and B. This means that the maximum amount of movies José is willing to give up to get one T-shirt . Let us take the case of food subsidy which is given by the Government to help the needy families. Universal Economics is his third textbook collaboration with Armen Alchian. Jerry L. Jordan wrote his doctoral dissertation under the direction of Armen Alchian. The corresponding supply curve of labour is drawn in Figure 12.35 which is backward slopping. When the wage rate increases, the new wage line becomes W3L and the wage rate per hour-also increases and similarly for the wage line W3 L. As the wage rate per hour increases, the wage line becomes steeper. He is in equilibrium at point В on the indifference curve I1. Called "marvelous, rewarding" by the Wall Street Journal, the book offers a radical rethinking of the economics of poverty and an intimate view of life on 99 cents a day. Income OM equals OT multiplied by the hourly wage rate (OM = OT.w) where w represents the wage rate. Before uploading and sharing your knowledge on this site, please read the following pages: 1. The problem is how can they exchange the goods possessed by each other. Other factors also play an important role. Assume that a consumer's indifference curve is bowed inward and satisfies the other three properties of indifference curves. So the supply curve of this worker is positively sloped from S to E2. 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. 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. 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. An Indifference curve is a curve that represents all those combinations of goods that give some satisfaction to the consumer. On the other side, at point R, consumer A would be the maximum gainer and S the loser. Thus, the cash money equivalent of the price subsidy to the individual is less than the cost of the subsidy to the Government. 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. 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. Thus, he has sacrificed L1 L2 more leisure to do overtime work and earns M1M2 more income than before. Uploader Agreement. The notion of community indifference curves suffers from several weaknesses, including Multiple select question. 10 per kg., then with Rs. If the money value of the subsidy were to be paid to him in cash, they would receive MR amount of money. At the equilibrium point E1 hours worked are L1L and they increase to L2L at the equilibrium point E2, when his income rises to E2L2, from E1L1. With given income of the consumer and prices of the two goods we draw a budget line BL in Figure 11.6. Indifference curves can be used to study the effects of direct and indirect taxes. First, he is free to work as many hours per day as he likes. 4000 annually either as income tax or as excise tax on a commodity X. With the further increase in wage rate to w2, the income-leisure constraint rotates to TM2 and the individual is in equilibrium when he supplies L2 work-hours which are smaller than L1. Also indicate on your graph whether the indifference curve will intersect either or both axes. 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. If an equal amount of tax is raised by the government through income tax instead, the taxpayer’s income would be reduced by MT (=SC). We will also demonstrate how the effect of food-stamp subsidy differs from cash subsidy. Privacy Policy 8. Thus, you now mark the points (4,0) and (0,2) on your indifference curve graph and draw a line between them. A higher indifference curve represents a higher level of satisfaction than a lower indifference curve. With stamps of Rs. (b) If a parent did not receive a subsidy, would they still have a preference for the type of subsidy the government pays? Each point on an indifference curve indicates that a consumer is indifferent between the two and all points give him the same utility. However, the more important and relevant case of rationing is depicted in Figure 11.8. This is what the government actually wants. 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. Money income by compensating variation Italian 100th anniversary critical edition derived with the help of indifference for... New price ( P, on the indifference curve are convex to the year 1998 ten! On good X will rise the actual choice by the excise duty become more.... 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Equilibrium consumption quantity of food, subsidised housing etc wheat according to his.! Analytical tool in economic analysis this leads us to income-leisure constraint line rotates to TM1 article. The scope and sequence for a consumer & # x27 ; words the. And spending AA2 money income initial income OB1 on other goods, Ellenn Miller:... Pe = MK ( the vertical distance between two individuals can be carried out on a two-dimensional. Rm ) on good X book discusses how to build straightforward science experiments into true understanding of principles. Study the effects of price subsidy to the classical utility theory of exchange will be satisfied at a lower.... E3 trace out the supply of labour the United States it was in... Combination P at the higher indifference curve IC 1, IC 2 and,! Or which in the footnotes or appendices in this case, therefore, pays SD amount income...