Indifference Curves

Abstract

There are two elements in every choice: (1) preferences (the desirability of various goods) and (2) opportunities (the attainability of various goods). The indifference curve relates to the former: the preferences of an individual. It separates better (more preferred by this individual) bundles of goods from inferior (less preferred) bundles, providing a diagrammatic picture of how an individual ranks alternative consumption bundles. To illustrate indifference curves, we begin with the title character from the classic Robinson Crusoe, by Daniel Defoe, published in 1719 and thought to be the fi rst English novel. Crusoe was shipwrecked on a desert island. In Exhibit A-1, we assume that he is initially consuming eight fi sh and eight breadfruit per week (point A). This initial bundle provides him with a certain level of satisfaction (utility). He would, however, be willing to trade this initial bundle for certain other consumption alternatives if the opportunity presented itself. Because he likes both fi sh and breadfruit, he would especially like to obtain bundles to the northeast of point A in the diagram, because they represent more of both goods. However, he would also be willing to give up some breadfruit if in return he received a compensatory amount of fi sh. Similarly, if the terms of trade were right, he would be willing to exchange fi sh for breadfruit. The trade-offs he is just willing to make—those that would make him no better and no worse off—lie along the indifference curve. Of course, he is happy to move to any bundle on a higher indifference curve. Starting from point A (eight fi sh and eight breadfruit), we ask Crusoe if he is willing to trade that bundle for various other bundles. He answers “Yes” (Y), “No” (N), or “I do not care” (i). Exhibit A-1 shows the pattern of his responses. Crusoe’s “I do not care” answers indicate that the original bundle (point A) and each alternative indicated by an i are valued equally by Crusoe. These i points, when connected, form the indifference curve. This line separates the preferred bundles of fi sh and breadfruit from the less-valued combinations. Note that such a curve is likely to be entirely different for any two people. The preferences of individuals vary widely. We can establish a new indifference curve for the individual by starting from any point not on the original curve and following the same procedure. If we start with a point (a consumption bundle) to the northeast of the original indifference curve, all points on the new curve will have a higher level of satisfaction for Crusoe than any on the old curve. The new curve will probably have about the same shape as the original.