Before we talk about choices, preferences, trade-offs and indifference curves, we should briefly look over some key terms. We assume people are rational decisions makers and that there is almost nothing someone is unwilling to trade for correct compensation.
Non-Satiation Assumption: If some is good, more is better. Consumers always prefer more of any good or service to less. Nonsatiated preferences are a common assumption in economic models of consumer behavior.
Maximization Assumption: Individuals always make choices that maximize their preference ordering.
The implications of these two terms are:
1. Scarcity, in that one will always want more than available.
2. People always fully exploit opportunities (all gains from trade are exhausted in equilibrium).
3. Imposes argument to explain behaviour.
Trade Offs and Indifference Curves
With that in mind, the indifference curve comes into play listing all the possible preference bundles occupying the same position in a preference ordering indifference curve (IC). Any two bundles on an IC must satisfy indifference statement.
Trade-Offs: concern movement along the IC; willingness to make trade off suggests that different combination can yield the same level of satisfaction.
Continuity Assumption: Through any consumption bundle in which the quantity of at least one good is positive, there is a continuous IC.
Remember the rule that when a non-satiation assumption is satisfied, the slope of any IC is negative as seen below.
The Indifference Map
Because the preference ordering is complete, we know there’s an indifference curve through EVERY bundle. The non-satiation assumption also implies that bundles on the indifference curve farther from t he origin are preferred to bundles closer to the origin.
A note, indifference curves are non-intersecting. Transitivity assumption implies that IC’s cannot intersect.