When the price of a commodity is reduced the consumer will attain higher level of satisfaction as studied in price effect. Examples of bad commodities can be disease, pollution etc. Her marginal rate of substitution between points S and T is 2; her indifference curve is steeper than the budget line at point S. Effect of Subsidies to Consumers: Price Subsidy Vs. Then we can draw some conclusions about the choices a utility-maximizing consumer could be expected to make. To the consumer, bundle A and B are the same as both of them give him the equal satisfaction. She is spending all of her budget, but she is not maximizing utility.
Let us understand this with the help of following indifference schedule, which shows all the combinations giving equal satisfaction to the consumer. Such combinations are inferior to combinations on the indifference curve. A price-budget-line change that kept a consumer in equilibrium on the same indifference curve: in Fig. In the grid you used to draw the budget lines, draw an indifference curve passing through the combinations shown, and label the corresponding points A, B, and C. Lastly, out of the two possibilities of the effects of food-stamp subsidy and cash subsidy which is the most common result, that is, the most common outcome of the two possible cases presented in Fig.
The table given below is an example of indifference schedule and the graph that follows is the illustration of that schedule. Marginal Utility and Price The slope of the indifference curve shows the marginal rate of substitution of good X for good Y, while the slope of price line indicates the ratio between prices of two goods i. When the man drinks 12 cup of coffee, he consumes 1 cigarette every day. An example of an indifference map with three indifference curves represented In , an indifference curve connects points on a graph representing different quantities of two goods, points between which a consumer is indifferent. Thus, all other combinations on both curves would have to provide the same level of satisfaction as well. Another important result obtained from our above analysis is that even with food stamps programme the individual increases the consumption of all other goods i.
Thus, movement from point S to H and as a result the decrease in labour supply by L 2 L 1 represents the income effect of the rise in wage rate. However, the assumptions of consumer preference theory do not guarantee that the demand curve will have a negative slope. Indifference curve A from is inferior to indifference curve B. This is a substitution effect of the rise in wage rate tends to reduce leisure and increase labour supply i. One good can be substituted for another. It is thus clear that for an individual supplier of labour income effect and substitution effects work in opposite directions. A collection of selected indifference curves, illustrated graphically, is referred to as an indifference map.
However, the more important and relevant case of rationing is depicted in Figure 11. At the point of equilibrium, indifference curve must be convex to the origin. All points P, Q, R, S and T on the curve show different combinations of apples and bananas. Another point which is worth mentioning in this regard is that indifference curves cannot even meet or touch each other or be tangent to each other at a point. Higher Indifference Curves Are Preferred to Lower Ones Consumers will always prefer a higher indifference curve to a lower one. More is always preferred to less because all goods are desirable 4. It can be explained with the help of the following table: The above table reveals that different combinations, namely, A, B, C, D, E, F of two commodities X and Y can be purchased by the consumer with his given income Rs.
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. Rather, it makes use of ordinal numbers like 1 st, 2 nd, 3 rd, 4 th, etc. When he started consuming two cigarettes a day, his coffee consumption dropped to 8 cups a day. In the diagram ΔY and ΔX show the decrease in commodity Y and increase in commodity X when both are substituted in order to remain on the same level of satisfaction. This enables him to move to higher and higher indifference curves and choose a new optimum bundle of x 1 and x 2. Indifference curve cannot intersect each other Each indifference curve is a representation of particular level of satisfaction. As in case of change in price, rise in wage rate has both the substitution effect and income effect.
But E cannot be the position of stable equilibrium because satisfaction would not be maximum. A very risk aversed person would give the meter money and then some because they don't know how long they'll be Risk neutral people will give it a little money and let it ride at the end Risk takers will let the meter ride. Many core principles of appear in indifference curve analysis, including individual choice, marginal utility theory, income and substitution effects, and the subjective theory of value. 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. 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.
You can browse or download additional books there. Assumptions of Indifference Curve Analysis : The indifference curve analysis retains some of the assumptions of the cardinal theory, rejects others and formulates its own. Diminishing marginal rate of substitution Marginal rate of substitution may be defined as the amount of a commodity that a consumer is willing to trade off for another commodity, as long as the second commodity provides same level of utility as the first one. Check out the illustration below to see this. I've drawn a brown line between them, which you can see on Indifference Curve vs. Indifference curves are heuristic devices used in contemporary microeconomics to demonstrate consumer preference and the limitations of a budget.
At the extreme, when two goods cannot at all be substituted for each other, that is, when the two goods are perfect complementary goods, as for example gasoline and coolant in a car, the indifference curve will consist of two straight lines with a right angle bent which is convex to the origin as shown in Fig. In Fig-1, the slope of the price line equal to the price of goods X and good Y. The answer, of course, is that the definition of slope has not changed. She achieved it by selecting a point at which an indifference curve was tangent to her budget line. An individual demand curve shows the relationship between price and quantity demanded holding all else - income, prices of other goods, tastes etc. This means that the Engel curve for x 1 is a vertical straight line.