The ICs of Fig. The degree of convexity of an indifference curve depends on the rate of fall in the marginal rate of substitution of X for Y. It also studies the cross effect when with change in the consumers income, the price of the other good also changes. The utility analysis postulates the law of diminishing marginal utility which is applicable to all types of goods, including money. Since, IC2 is a lower curve than IC3, consumers level of satisfaction will be adversely affected by the income tax, but since IC2 is a higher curve than IC1 his well-being will not be as adversely affected as done by the excise tax. 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. Marshall failed to explain these cases. Fig. Because of the shape of the consumers ICs and that of his budget constraint, he would achieve the highest possible level of satisfaction at c, the point of tangency between his budget line and one of his ICs. A consumer is in equilibrium when he maximizes his satisfaction subject to a limited money income and given market prices of goods and services. 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. Content Filtration 6. To keep things simple, we shall examine the decision facing a consumer who lives for two periods. This is the income effect. Such a situation arises because a consumer consumes a large number of goods and services. We shall also assume here that Y stands for all the goods other than X, and the consumers money income to be spent on the two goods is M. We shall discuss the effects of the taxes with the help of Fig. First, the consumers real income has decreased. Indifference Curves are Convex towards the Origin: Indifference curves are convex towards the origin because marginal rate of substitution continously decreases (because as the stock of one commodity decreases its marginal importance for the consumer will continously increases and as the stock of another commodity increases its marginal . They are convex to the origin. Some of these important properties of indifference curve are as follows: 1. The model may be considered to be an application of the indifference curve theory. 3.11 illustrates the consumer's equilibrium. Indifference curve analysis is based on the assumption of the diminishing marginal rate of substitution. Given the combination of Lillys personal preferences, as identified by her indifference curves, and Lillys opportunity set, which is determined by prices and income, B will be her utility-maximizing choice. The prices of the goods X and Y are fixed for the consumer. Let us note that his consumption of X is higher under the income tax than under the excise tax (GE > FD), since, under the excise tax, he is at the point D, but under the income tax, he has further opportunity to maximise in the region of the triangle DB1B2. The consumers equilibrium point now would move from the point D (C1, C2) on IC2 to the point E(C, C) on a lower IC, viz., IC1, indicating that the consumers real income has decreased. To understand why higher indifference curves are preferred to lower ones, compare point B on indifference curve Um to point F on indifference curve Uh. 5.2 Ordinal Utility. (with diagram), Indifference Curve Approach (With Uses) | Economics. Thus, while indifference curves have the same general shapethey slope down, and the slope is steeper on the left and flatter on the rightthe specific shape of indifference curves can be different for every person. He is indifferent about his choice. Second, since r has increased, period 1 consumption (C,) has become relatively dearer and period 2 consumption has become relatively cheaper. It means that it cannot be efficient to have total consumption of any good which is less than the output of the good. An indifference curve denotes a set of different combinations of two commodities or goods, providing the same level of satisfaction to the consumer. Say that books cost $6, doughnuts are 50 cents each, and that Lilly has $60 to spend. Since all the combinations give the same amount of satisfaction, the consumer prefers them equally. 4.3 Indifference Curves are convex to the origin. An indifference curve is a line showing all the combinations of two goods which give a consumer equal utility. What is Lillys utility-maximizing choice? Under this programme, the low-income families receive food stamps which they can use to purchase food only. As we know, the movement of the consumers equilibrium point from D to E represents the total effect of the rise in r. We may break up this effect into an IE and an SE. Choices B and G are both on the opportunity set. 1 In economics, indifference curves show which goods in the marketplace bring equal satisfaction to consumers, leaving them indifferent to which goods they purchase. In other words, they are steeper on the left and flatter on the right. Thus, her marginal utility from an extra book will be relatively high while the marginal utility of additional doughnuts is relatively lowso on the margin, it will take a relatively large number of doughnuts to offset the utility from the marginal book. Content Guidelines 2. That is why the post-income tax budget line of the consumer would be A2B2 it would pass through the point D. Now, the consumer would be in equilibrium at the point of tangency E between the budget line A2B2 and the curve IC2. 6.96(a) AB is the budget line of the consumer before he receives any form of subsidy. Consequently, the horizontal (CO intercept of the budget line, i.e., Y1 + Y2/ (1 + r), would diminish and the vertical (C2) intercept of the line, i.e., (1 + r) Y1 + Y2, would increase. (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. Such a diagram is known as an indifference map where each indifference curve corresponds to a different indifference schedule of the consumer. 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. The degree of convexity of an indifference curve depends upon the rate of fall in the marginal rate of substitution of X for Y. Nederlnsk - Frysk (Visser W.), Handboek Caribisch Staatsrecht (Arie Bernardus Rijn), The Importance of Being Earnest (Oscar Wilde), English (Robert Rueda; Tina Saldivar; Lynne Shapiro; Shane Templeton; Houghton Mifflin Company Staff), Auditing and Assurance Services: an Applied Approach (Iris Stuart), Managerial Accounting (Ray Garrison; Eric Noreen; Peter C. Brewer), Junqueira's Basic Histology (Anthony L. Mescher), Big Data, Data Mining, and Machine Learning (Jared Dean), Principles of Marketing (Philip Kotler; Gary Armstrong; Valerie Trifts; Peggy H. Cunningham), Applied Statistics and Probability for Engineers (Douglas C. Montgomery; George C. Runger). He has moved from a higher IC (IC2) to a lower IC (IC1). 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. We have examined three different situations in Fig. 6.97(b) illustrates the case where the ICs of the consumer are so positioned that he will prefer the cash subsidy even if taxed to the untaxed in-kind subsidy. Fig. Report a Violation 11. Fig. In Fig. In Figure 6, consider the indifference curves I 1 and I 2 and combination N and A respectively on them. The stamps are non-tradable (if they were tradable, then the programme would have reduced to a general cash subsidy programme). A normal indifference curve will be convex to the origin and it cannot be concave. Top 9 Properties of Indifference Curve (With Diagram), Top 6 Properties of Indifference Curve (With Diagram), 4 Assumptions to Explain the Equilibrium of the Consumer (with curve diagram), Indifference Curve Approach: Ordinal Utility, Nations of Preference and Assumptions. It may be verified in Fig. It can slope or bend backward too which implies that at a higher wage rate, the individual will supply less labour (i.e. Each person determines his or her own preferences and utility. Consumers would prefer to move in the direction indicated by the arrow in the figure. The amount of cash subsidy here is BB1.px, or, AA1.py. If we assume that both C1 and C2 are normal goods, then both would in- c, crease after an increase in income and the consumers new equilibrium point Q2 would be positioned upward towards right of his initial equilibrium point Q1. The indifference curve technique can be used to measure the effects of government subsidy on low income groups. Therefore, now, the consumers budget line would become AC B1 in Fig. These questions allow you to get as much practice as you need, as you can click the link at the top of the first question (Try another version of these questions) to get a new set of questions. In order to derive the consumers budget constraint we have to combine equations (6.131) and (6.132) and thereby we obtain. Practice until you feel comfortable doing the questions. 4.2 Higher IC represents a higher satisfaction level. We shall see that the typical consumer is better off with an income tax than with a comparable excise tax on a single commodity. From this starting point, her marginal utility gained from extra books will be relatively low, while the marginal utility lost from additional doughnuts would be relatively highso on the margin, it will take a relatively smaller number of doughnuts to offset the change of one marginal book. On the other hand, if period-1 consumption exceeds period-1 income, the consumer is borrowing (S < 0). Indifference curves like Um are steeper on the left and flatter on the right. In the preference theory, this law has been replaced by the principle of diminishing marginal rate of substitution. A single indifference curve concerns only one level of satisfaction. Since the consumer is borrower in period 1, we have C1 > Y1 and C2 < Y2, i.e., the point D lies downward towards right of point A. Nine most . Indifference Curve Analysis Therefore, the consumer will be indifferent between the two types of subsidy. Thus, because of the imposition of the excise tax, the consumers utility level has worsened. This numerical slope, as we know, is known as the marginal rate of substitution of C1 for C2. This website uses cookies and third party services. We may compare the effects of cash subsidy and in-kind subsidy upon the consumers utility level with the help of Fig. The greater the fall in marginal rate of substitution, the greater the convexity of the indifference curve. importance of indifference curve with diagramis avner kaufman alive. In microeconomics, indifference curve is an important tool of analysis in the study of consumer behavior. Along with the budget line are shown the three indifference curves from Figure 1. However, it is not affordable given Lillys budget constraint. 6.99 are not straight lines. If the sellers can pass on the whole tax to the consumers, the price of X will rise by the amount of the tax, and the x-intercept of the budget line will reduce from OB to OB1, and the post-tax budget line would become AB1. Now, if the consumer is asked to pay an income tax of the amount DH.px in terms of money, or, DH.px/px = DH in terms of good X, then, prices of the goods remaining the same, his pre-tax budget line AB would have a horizontal and parallel leftward shift by an amount of DH = B2B. Since IC2 is a higher curve than IC1, the price subsidy increases his well-being but since IC2 is lower than IC3, his well-being will not improve as much as in the case of cash subsidy. Consequently, the cash subsidy budget line, net of tax, will be A2B2it would be to the left of A1B1 but parallel to it because the prices remain unchanged. Privacy Policy 9. Lilly would receive equal utility from all combinations of books and doughnuts on a given indifference curve. 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. Marshall justified it on the plea that an individual consumer spends only a small part of his whole expenditure on any one thing at a time. The numerical slope of the budget line is: The budget constraint of the consumer states that the present value of consumption in the two period should be equal to that of the income of the two periods. The indifference curve technique explains consumers equilibrium in a similar but better way than the Marshallian proportionality rule. In our case, this amount is BB1 along the horizontal axis. This website uses cookies and third party services. The application of this principle in the fields of consumption, production and distribution has made economics more realistic. A consumer is better off with an income tax than with a comparable excise tax a... Indifference curve analysis therefore, the consumers utility level has worsened books cost $ 6 importance of indifference curve with diagram the... 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