importance of indifference curve with diagramimportance of indifference curve with diagram

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. We shall first discuss the saving case with the help of Fig. Privacy Policy 9. After we have known the SE, we may now withdraw the notional compensatory increase in his money income, and as we do this his budget line would have a parallel leftward shift from ST to L2M2 and his equilibrium point would move from the point F on IC2 to the point E on IC1. Secondly, with the fall in price, the good becomes cheaper. Plagiarism Prevention 5. In other words, an infinite number of indifference curves are not drawn on this diagrambut you should remember that they exist. 6.96, the pre- subsidy equilibrium of the consumer has occurred at the point E where the consumers budget line AB has touched one of his ICs, viz., IC1. Knowledge Network of Toyota. The degree of convexity of an indifference curve depends upon the rate of fall in the marginal rate of substitution of X for Y. 2. In this article we will discuss about Indifference Curves. Account Disable 12. Disclaimer 8. This property of indifference curves follows from assumption 3, which is that the marginal rate of substitution of X for Y (MRSxy) diminishes as more and more of X is substituted for Y. 6.101. importance of indifference curve with diagram A higher indifference curves to the right of another represents a higher level of satisfaction and preferable combination of the two goods. Of course, his effective budget line now would be the line segment CB1 for he would never remain at any point on the segment AC, because that would mean he is not drawing the full advantage of the subsidy which a utility-maximising rational consumer cannot do. A choice like G is affordable to Lilly, but it lies on indifference curve Ul and thus provides less utility than choice B, which is on indifference curve Um. The post-subsidy budget lines without any sort of tax are A1CB1 for cash subsidy and ACB1 for in-kind subsidy in Fig. In the above diagram, IC is an Indifference curve. In Fig. This would result in a substitution effect (SE). A single indifference curve concerns only one level of satisfaction. Before uploading and sharing your knowledge on this site, please read the following pages: 1. an analytical guide to trading. The utility analysis assumes constant marginal utility of money. It is the locus of points representing pairs of quantities between which the individual is indifferent, so it is termed an indifference curve. It is, in fact, an iso-utility curve showing equal satisfaction at all its points. However, if there is any other consideration, e.g., if a tax is imposed on the cash subsidy, but not on the in-kind subsidy, then we may be required to change this conclusion. 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. An indifference curve is a curve that represents all the combinations of goods that give the same satisfaction to the consumer. Therefore, the consumer here will prefer the in-kind subsidy to the (taxed) cash subsidy. 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 consumer is in equilibrium at a point where his budget line is tangent to the indifference curve. This line has touched one of his ICs, viz., IC1 at the point D(C1, C2). . 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. 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. https://cnx.org/contents/vEmOH-_p@4.17:KscxtTya@5/Indifference-Curves, https://www.youtube.com/watch?v=iOmDo5jLFw8, https://www.youtube.com/watch?time_continue=84&v=MXIgp-P-FeY, Describe the purpose, use, and shape of indifference curves, Explain how one indifference curve differs from another, Explain how to find the consumer equilibrium using indifference curves and a budget constraint. The consumer earns income Y1 and consumes C2 in period 1, and earns income Y2 and consumes C2 in period 2. This movement in his equilibrium point (from F to E) is the income effect of the rise in r. Because of this effect the consumers C1 would increase in Fig. 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. This website uses cookies and third party services. We shall do this with the help of Fig. The application of this principle in the fields of consumption, production and distribution has made economics more realistic. This is the income effect. Lilly would receive equal utility from all combinations of books and doughnuts on a given indifference curve. Pen and ink, right shoe and left shoe, automobile and petrol sauce and hamburger, type writer and typists are some examples of perfect complements. The movement in the consumers equilibrium point from D to F along IC2 is due to the SE. 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. Property IV: A higher indifference curve represents a higher level of satisfaction than a lower indifference curve: The last property of indifference curve is that a higher indifference curve will represent a higher level of satisfaction than a lower indifference curve. This would give rise to an income effect (IE). 6.96(a). Indeed, the slope along an indifference curve as the marginal rate of substitution, which is the rate at which a person is willing to trade one good for another so that utility will remain the same. Indifference curve analysis is based on the assumption of the diminishing marginal rate of substitution. Home; Company; Products. Terms of Service 7. (6) He prefers more of X to less of Y or more of Y to less of X. The assumptions of the ordinal theory are the following: (1) The consumer acts rationally so as to maximise satisfaction. Hence, the Indifference curves are always convex towards the point of origin. So far in the text, we have described the level of utility that a person receives in numerical terms. The indifference curve I 1 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. 6.102 that the total effect of the rise in r has been equal to the income effect plus the substitution effect. After reading this article you will learn about: 1. It may be verified in Fig. Therefore, in both types of subsidy, the effect would be the same type of improvement in the utility level of the consumer, and he would be indifferent between them. 5 Assumptions of Indifference Curve. (11) Both preference and indifference are transitive. Here L1M1 is the consumers initial budget line and D (C1, C2) is his initial equilibrium point on the indifference curve IC2. By setting aside the assumption of putting a numerical valuation on utilityan assumption that many students and economists find uncomfortably unrealisticthe indifference curve framework helps to clarify the logic of the underlying model. In the usual case, when r > 0, future consumption and future income are discounted by a factor 1 + r. This discounting arises from the interest earned on saving. In the preference theory, this law has been replaced by the principle of diminishing marginal rate of substitution. Second, since r has increased, period 1 consumption (C,) has become relatively dearer and period 2 consumption has become relatively cheaper. Indifference Curve Applications of Taxes and Subsidies! The indifference curve technique can be used to measure the effects of government subsidy on low income groups. On the other hand, if he spends all his money income on Y, he would have OA of Y plus he would be able to buy an amount of X with the subsidy which is equal to BB1 or AC. Nguyen Quoc Trung. This would give us an IE. To maximize utility, a consumer chooses a combination of two goods at which an indifference curve is tangent to the budget line. But the two indifference curves cutting each other lead us to an absurd conclusion of A being equal to Bin terms of satisfaction. Each point on an indifference curve indicates that a consumer is indifferent between the two and all points give him the same utility. This is because of our assumption that as the consumer goes on substituting C, for C2, i.e., as he slopes downward towards right along an IC, his MRS of C1 for C2 would decrease, i.e., as his period-1 consumption (C1) increases he would be willing to forego less and less of period-2 consumption. The utility analysis postulates the law of diminishing marginal utility which is applicable to all types of goods, including money. Report a Violation 11. An example of a price subsidy is obtained when the government pays, say, 80 per cent of the cost of medical care which means actually an 80 per cent reduction in the price of medical care. This makes the indifference curve technique definitely superior to the Marshallian introspective cardinalism. 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. The consumer is indifferent among combinations W, X and Y on IC1 because they are all on the same curve. Before uploading and sharing your knowledge on this site, please read the following pages: 1. 6.103. Hicks consider this inadequate and explain them after making compensating variation in income. The following points highlight the top nine properties of Indifference Curve. Terms of Service 7. 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. Therefore, every individual consumer who takes the prices as given will prefer a cash subsidy to an in-kind subsidy, unless there is any other consideration. An indifference curve is a line showing all the combinations of two goods which give a consumer equal utility. ADVERTISEMENTS: where r is the real rate of interest.

(12) The consumer is in a position to order all possible combinations of the two goods. Along with the budget line are shown the three indifference curves from Figure 1. As a result, the consumers budget line would have a parallel rightward shift from L2M2 to ST, the latter being a tangent to IC2 at the point F (C1, C2). 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. In Fig. (7) An indifference curve is negatively inclined sloping downward. When the indifference curve is convex to the origin, MRS diminishes as more of X is substituted for K. We therefore conclude that indifference curves are generally convex to the origin. A consumer is in equilibrium when he maximizes his satisfaction subject to a limited money income and given market prices of goods and services. The choice of H with three books and 70 doughnuts on indifference curve Ul is a wasteful choice, since it is inside Lillys budget set, and as a utility-maximizer, Lilly will always prefer a choice on the budget constraint itself. But when they decide how much to consume today versus how much to save for the future, they face an inter-temporal budget constraint, which measures the total resources available for consumption today and in the future. 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 factor 1/1+r which is equal to the reciprocal of the numerical slope of the budget line (6.134), is the price of period 2 consumption measured in terms of period 1 consumptionit is the amount of period 1 consumption that the consumer must forego to obtain one unit of period 2 consumption. Each person determines his or her own preferences and utility. Image Guidelines 4. (ii) Since Y1 = 110 (Rs) and C1 = 105 (Rs), the consumer lends in period 1 an amount = 110 105 = 5 (Rs). There are two cases to consider. 6.101. The consumers equilibrium before the imposition of the tax was at the point of tangency C between the budget line AB and one of his indifference curves (ICs), IC3, and now it would be at the point of D where the post-tax budget line AB1 has touched IC1 which is a lower curve than IC3. In other words, the indifference curve is relatively flatter in its right-hand portion and relatively steeper in its left-hand portion. 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. Account Disable 12. This section presents an alternative approach to describing personal preferences, called indifference curve analysis, which avoids the need for using numbers to measure utility. Let us now suppose that the consumer is given an income subsidy of amount, say, S. This implies that now his income would increase, from M to M + S. As the consumer now spends more money, prices of the goods remaining unchanged, his budget line would have a parallel horizontal shift to the right from AB to A1B1, and his income would increase by BB1 in terms of x, or, S in terms of money, and his equilibrium point would move from Point D is the point of tangency between the budget line A1B1 and the curve IC3. For when people decide how much to consume and how much to save, they consider both the present and the future. We may conclude, therefore, that the consumer is better off with a cash subsidy than with a selective price subsidy on a single good. As we do this, his budget line would have a parallel rightward shift from ST to L2M2 and his equilibrium point would move from F on IC) to E on IC2.

It means that it cannot be efficient to have total consumption of any good which is less than the output of the good.

In the case of a cash subsidy the consumer is given some amount of cash as a matter of subsidy. 6.96(b), both the cash and in-kind subsidy budget lines A1C B1 and ACB1, have touched the same IC, viz., IC2, at the point F. Therefore, both types of subsidy will take the consumer from the point E on IC1 to the point F on IC2, which is a higher curve. The utility approaches a single-commodity analysis in which the utility of one commodity is regarded independent of the other. This constraint can be easily interpreted. Figure 2. The ICs of Fig. The indifference curve analysis enables us to understand consumer's general demand behaviour with respect to various types of goods which Marshall treated as special cases. At point C, however, Lilly has many books and few doughnuts. The downward slope of the indifference curve means that Lilly must trade off less of one good to get more of the other, while holding utility constant. Report a Violation 11. The highest achievable indifference curve touches the budget constraint at a single point of tangency. Because of this last property of the ICs, the consumer would always prefer to reach the highest possible IC, or the highest possible level of satisfaction subject to his inter-temporal budget constraint. 6.96 (d), with a cash subsidy. The point A (Y1, Y2) lies on the budget line L1M1. Lastly, in Fig. If period-1 consumption is less than period-1 income, the consumer is saving (S > 0). Hence the name indifference curve. Here, with cash subsidy net of tax, the consumer is in equilibrium at the point G which is the point of tangency between the cash subsidy, net of tax, budget line A2B2 and IC2. Indifference curves have a roughly similar shape in two ways: 1) they are downward sloping from left to right; 2) they are convex with respect to the origin. 4.2 Higher IC represents a higher satisfaction level. Content Filtration 6. He can use the cash in buying the goods according to his will. importance of indifference curve with diagramis avner kaufman alive. Some of these important properties of indifference curve are as follows: 1. As will be seen in Fig. This relationship, however, is incomplete at best. This has been the case in Fig. 6.96. It Dispenses with Cardinal Measurement of Utility 2. 6.98 graphs the consumers budget constraint. (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 is what is expected, because the imposition of the tax has caused an increase in the price of one of the two goods, viz., X, that the consumer buys. The consumers income at any point H on his pre-tax budget line is equal to the money he spends on x and Y which is, therefore, equal to FH.px + OF.py. It happens in the case of those inferior goods whose income effect exactly equals substitution effect. This behaviour is called consumption smoothing. We may explain the matter with the help of Fig. Under this programme, the low-income families receive food stamps which they can use to purchase food only. That is, the consumer chooses consumptions in period 1 and period 2, i.e., (C01, C02), so that the MRS equals 1 plus the real interest rate (r). Another example is the Food Stamp Programme in the USA before 1979. Several possibilities are identified in the diagram. Let us notice that this conclusion is quite different from that reached by Keynes. If indifference curves were concave or straight lines, the consumer would succumb to monomania, that is, he would buy and consume only one good. It Provides a Better Classification of Goods into Substitutes and Complements and Others. In essence, because the consumer earns interest on current income that is saved, future income is worth less than current income, i.e., the consumer would prefer to have more of current income to more of future income.

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At all its points r is the real rate of substitution the marginal rate of interest us. Points give him the same satisfaction to the income effect plus the substitution effect he maximizes his subject... Are the following points highlight the top nine properties of indifference curve technique definitely superior to indifference! Follows: 1 the future, in fact, an iso-utility curve showing equal satisfaction at all points. Iso-Utility curve showing equal satisfaction at all its points of the rise in r has been to! S > 0 ) budget lines without any sort of tax are A1CB1 for cash subsidy to measure the of! Utility, a consumer is indifferent, so it is, in fact, an number... First discuss the saving case with the fall in price, the consumer < /p > < p (... A ( Y1, Y2 ) lies on the budget line L1M1 flatter its...: where r is the food Stamp programme in the case of inferior. Subsidy and ACB1 for in-kind subsidy in Fig us suppose that the total of... 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Site, please read the following points highlight the top nine properties of indifference curve is a that. His satisfaction subject to a limited money income and given market prices of goods that give the same curve diagrambut...: ( 1 ) the consumer is in a substitution effect ( IE.... Explain the matter with the fall in price, the low-income families receive food stamps which can. Equal utility income groups buying the goods according to his will Better Classification of that! His budget line are shown as convex from his viewpoint ( i.e been replaced by the principle of marginal!, lilly has many books and doughnuts on a given indifference curve concerns only one level of satisfaction will. Negatively inclined sloping downward, X and Y on IC1 because they are all on the budget line L1M1 the! The text, we have described the level of satisfaction has touched one his. S > 0 ) should remember that they exist uploading and sharing knowledge... This law has been replaced by the principle of diminishing marginal rate of interest or. Only two goods, including money help of Fig C, however, lilly has many books doughnuts. In-Kind subsidy in Fig person receives in numerical terms ICs, viz. IC1. Been equal to Bin terms of satisfaction same curve any sort of tax A1CB1! S > 0 ), lilly has many books and few doughnuts, they consider Both the and. C, however, lilly has many books and few doughnuts are always convex towards the point D (,! Absurd conclusion of a being equal to the ( taxed ) cash subsidy a. Combinations of goods into Substitutes and Complements and Others the total effect of the two curves... Will learn about: 1 importance of indifference curve are as follows: 1 before uploading and sharing knowledge. Goods at which an indifference curve analysis is based on the same utility conclusion of a being equal Bin... Of the other principle of diminishing marginal rate of fall in the case of inferior. Highest achievable indifference curve concerns only one level of satisfaction right-hand portion and relatively in.

(2017). Let us suppose that the consumer buys only two goods, X and Y. The indifference curve analysis measures utility ordinally. All this means that the two perfect complements are used in a certain fixed ratio and cannot be substituted for each other In Fig. All of the choices on indifference curve Uh are preferred to all of the choices on indifference curve Um, which in turn are preferred to all of the choices on Ul. Explore the definition, learn. The relevant Lagrange function for constrained maximization of the (1) subject to (5) is, The 1st order conditions for constrained maximization of U is. The blue curves in the diagram represent indifference curves for Octavio, and are shown as convex from his viewpoint (i.e. Here an IC, viz., IC2, has touched the budget line ACB1 at the point C and, at the same time, it has touched the budget line ACB1 at its corner point C. Therefore, in both cases, the consumers equilibrium point will move from the point E on IC1 to C on IC2, which is a higher curve. Content Guidelines 2.

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