How Indifference Curves Represent Consumption Across Two Periods
Summary
The document explains how to read an indifference curve in a two-period consumption model. Each axis represents a monetary amount associated with a different period, and each point represents one allocation across those periods. A curve connects allocations that provide the same utility, so a person may be equally satisfied with more consumption in one period and less in the other. The axes use dollars because the model expresses consumption in monetary terms; they do not represent two different products.
The answer illustrates the idea with straight lines of equal total value: combinations such as one unit of X and nine of Y can be compared with other combinations totaling ten. A higher-total line is preferred in that simplified example. It then distinguishes equal-value lines from utility-based indifference curves, whose shapes depend on how the goods relate: perfect substitutes can produce straight lines, complements can produce right angles, and many goods produce curved lines. The explanation is introductory and does not derive a formal two-period budget constraint, interest rate, or optimization rule.
Key ideas
- Each point on an indifference curve represents a possible allocation between consumption in two periods.
- Points on the same curve provide equal utility to the modeled individual.
- A higher-valued allocation may be preferred, but equal total dollars are only a simplified illustration of equal utility.
- Curve shape reflects how readily the person substitutes consumption between periods.
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# What is this chart showing?
# What is this chart showing?
I am a software engineer studying business finance for the first time. I am really struggling with this chart. It's supposed to be the "two period model" showing the complete consumption tastes and preferences of individuals in a two-period world.
What gets me is that both the X and Y axes are marked as being $.
Can you please explain what the chart is actually showing? What does each point in the curve actually represent, and why/how does so?
ADDED: After reading the wikipedia page about it, I understand that the curve is meant to plot the points where a person is satisfied. So, it might have more of X and less than Y and still be happy -- or vice versa. So, I guess this is now applying the same concept but rather than having two different products, it's the amount of money in two different periods... am I on the right track?
## Answer by Magic is in the chain (score 1, accepted)
https://quant.stackexchange.com/a/51420
Consider a line through the scatter plot of X and Y, where the points are such that X+Y=10. i.e., if you plot the points {1,9}, {2,8}, {3,7},…,{9,1}, and draw a line through these points, you will get a downward sloping straight line. So this line represents the combination of X and Y such that the total amount is 10. If these represent the value of two assets, you will be indifferent between the points on this line as the total value is the same.
Next consider the points X and Y such that X+Y=20. You will get a straight line, which will be to the right of the previous line. Again you will be indifferent between the points on this line as they represent the same value of 20. But you would prefer a position on this line compared to a position on the previous line where X+Y=10.
The curves you have represent the same concepts but in terms of utility as opposed to value. The shapes of the indifference curves could be straight lines (where the goods are perfect substitute as in the value example above) or L shape (for complementary goods), or curved (for most goods). The axes are usually the quantity/number of units of the two goods.Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.