CHAPTER • Uncertainty and Consumer Behavior 169 Expected income Expected income U3 U2 U1 U3 U2 U1 Standard deviation of income (a) Standard deviation of income (b) F IGURE 5.5 RISK AVERSION AND INDIFFERENCE CURVES Part (a) applies to a person who is highly risk averse: An increase in this individual’s standard deviation of income requires a large increase in expected income if he or she is to remain equally well off Part (b) applies to a person who is only slightly risk averse: An increase in the standard deviation of income requires only a small increase in expected income if he or she is to remain equally well off RISK AVERSION AND INDIFFERENCE CURVES We can also describe the extent of a person’s risk aversion in terms of indifference curves that relate expected income to the variability of income, where the latter is measured by the standard deviation Figure 5.5 shows such indifference curves for two individuals, one who is highly risk averse and another who is only slightly risk averse Each indifference curve shows the combinations of expected income and standard deviation of income that give the individual the same amount of utility Observe that all of the indifference curves are upward sloping: Because risk is undesirable, the greater the amount of risk, the greater the expected income needed to make the individual equally well off Figure 5.5 (a) describes an individual who is highly risk averse Observe that in order to leave this person equally well off, an increase in the standard deviation of income requires a large increase in expected income Figure 5.5 (b) applies to a slightly risk-averse person In this case, a large increase in the standard deviation of income requires only a small increase in expected income In §3.1, we define an indifference curve as all market baskets that generate the same level of satisfaction for a consumer EX AMPLE BUSINESS EXECUTIVES AND THE CHOICE OF RISK Are business executives more risk loving than most people? When they are presented with alternative strategies, some risky, some safe, which they choose? In one study, 464 executives were asked to respond to a questionnaire describing risky situations that an individual might face as vice president of a hypothetical company.7 Respondents were presented with four risky events, each of which had a This example is based on Kenneth R MacCrimmon and Donald A Wehrung, “The Risk In-Basket,” Journal of Business 57 (1984): 367–87