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CHAPTER 2 THEORETICAL TOOLS OF PUBLIC FINANCE 27

Preferences and Indifference Curves


In modeling peoples preferences, we are not yet imposing any budget constraints;
we are simply asking what people prefer, ignoring what they can afford. Later, we
will impose budget constraints to round out the model.
Much of the power of the preferences models we use in this course derives
from one simple assumption: non-satiation, or more is better. Economists
assume that more of a good is always better than less. This does not mean that
you are equally happy with the tenth pizza as you are with the first; indeed, as
we learn later, your happiness increases less with each additional unit of a good
you consume. Non-satiation simply implies that having that tenth pizza is bet-
ter than not having it.
Armed with this central assumption, we can move on to graphically represent
a consumers preferences across different bundles of goods. Suppose, for example,
that Figure 2-1 represents Andreas preferences between two goods, CDs (with
quantity QC ) and movies (with quantity QM). Consider three bundles:
Bundle A: 2 CDs and 1 movie
Bundle B: 1 CD and 2 movies
Bundle C: 2 CDs and 2 movies indifference curve A graphi-
cal representation of all bundles
Lets assume, for now, that Andrea is indifferent between bundles A and B, of goods that make an individ-
but that she prefers C to either; she clearly prefers C because of the assump- ual equally well off. Because
tion that more is better. Given this assumption, we can map her preferences these bundles have equal utility,
an individual is indifferent as to
across the goods. We do so using an indifference curve, a curve that shows which bundle he consumes.
all combinations of consumption that give the individual the same amount of

FIGURE 2-1

Quantity of
CDs, QC Indifference Curves for Bundles
of CDs and Movies Andrea is
indifferent between consuming 2
CDs and 1 movie (point A) or 1 CD
and 2 movies (point B), but she
prefers 2 CDs and 2 movies (point
C) to both. Utility is the same along
A C a given indifference curve; indiffer-
2
ence curves farther from the origin
represent higher utility levels.
IC2
B (U = U2)
1
Indifference
curve,
IC1 (U = U1)

0 1 2 Quantity of movies, QM