Indifference Curves and Consumer Preferences in Economics

Representation of Preferences by Indifference Curves

An indifference curve shows the consumption baskets that yield the same level of satisfaction to the consumer. The consumer is indifferent between various combinations within the indifference curve. The slope at any point on an indifference curve is equal to the rate at which consumers are willing to substitute one good for another. This relationship is called the marginal rate of substitution (MRS). The rate at which a consumer is willing to trade Pepsi for pizza depends on who has more hunger or thirst, which depends in turn on how much pizza and Pepsi they have.

As a consumer prefers a larger quantity of goods, they prefer higher indifference curves to lower ones.

Four Properties of Indifference Curves

• Higher indifference curves are preferred to lower ones. Consumers prefer a larger quantity of goods to a smaller quantity.
• Indifference curves have a negative slope. The slope of an indifference curve reflects the rate at which consumers are willing to substitute one good for another. Reducing the amount of one good should be compensated by increasing the amount of the other for the consumer to maintain the same level of satisfaction.
• Indifference curves do not intersect. Since each curve represents a distinct level of satisfaction, with different amounts of either good, two indifference curves cannot intersect.
• Indifference curves are bowed inward. Individuals are more willing to exchange goods they have in abundance and less willing to exchange goods of which they have little. This results in the bowed shape of the indifference curve, reflecting the consumer's increased willingness to part with a good they already have a large amount of.

The Prisoner's Dilemma

Let us assume that both prisoners are completely selfish, and their sole goal is to minimize their own incarceration. As prisoners, they have two options: cooperate with their accomplice and stay quiet, or betray their accomplice and confess. The outcome of each choice depends on the choice of the accomplice. Unfortunately, they do not know what the other will choose. Even if they could talk to each other, they could not be certain of mutual trust.

Confessing is a dominant strategy for both players. Whatever the choice of the other player, each can always reduce their sentence by confessing. Unfortunately for the prisoners, this leads to a result in which both confess and both get long sentences. Herein lies the crux of the dilemma. The result of individual interactions produces an outcome that is not optimal. If one reasons from the perspective of the best interests of the group (of two prisoners), the correct result would be that both cooperate, as it would reduce the total time of sentencing for the group to a total of one year. Any other decision would be worse for both if taken together. However, if they follow their own selfish interests, each of the two prisoners receives a harsh sentence.