Choices. Preferences. Indifference Curves. Preference Relations. ECON 370: Microeconomic Theory Summer 2004 Rice University Stanley Gilbert

Transcription

1 Choices Preferences ECON 370: Microeconomic Theor Summer 2004 Rice Universit Stanle Gilbert The theor of consumer preferences is based fundamentall on choices The steak dinner or the salad bar Major in Economics or Engineering Save mone for retirement or take that vacation to Maui We sa a consumer Prefers bundle A to bundle B if: Assuming both are feasible And all else being equal ( cēterīs paribus!) She would choose bundle A instead of bundle B Econ Consumer Preferences 2 Preference Relations Consumers can compare two different consumption bundles, and : strict preference: is strictl preferred to weak preference: is at least as good as indifference: ~ These are ordinal (not cardinal) relations Onl order alternative bundles Do not specif magnitude of preference differences Indifference Curves An indifference curve (level set) Take a reference bundle Indifference curve: set of all bundles Good (Weakl) Preferred Set Indifference Curve Good Econ Consumer Preferences 3 Econ Consumer Preferences 4 1

2 Assumptions about Preferences Indifference Curves Cannot Intersect We usuall assume preferences meet the following assumptions: A1 Completeness: All bundles can be ranked. I 2 From, From I 2, A2 Transitivit: If and, then. A3 Non-Satiation: More is alwas better. Implies:, but A4 Conveit: The better-than set is conve. Econ Consumer Preferences 5 Econ Consumer Preferences 6 Non-Satiation Conveit Strictl Better b Two points on the same indifference curve Draw a line drawn between the two points Strictl Worse c a An point on that line will be at least as good Mathematicall: αa + (1 α)b a ~ b Econ Consumer Preferences 7 Econ Consumer Preferences 8 2

3 Non-Conve Eamples Comments about Assumptions Assumptions A1 & A2 are essential to our concept of rationalit Preferences that also meet Assumptions A3 & A4 are called Well Behaved. Non-Satiation This clearl does not appl in the real world We can usuall get awa with it because people will generall choose a consumption bundle in the region where more is still better (Wh?). Important eception: Bads Conveit There is no fundamental reason wh preferences should meet this Again, it is mathematicall convenient It also turns out not to matter much if it is not met I 3 I 2 Econ Consumer Preferences 9 Econ Consumer Preferences 10 Eamples of Preferences Eamples that meet our assumptions: Perfect Substitutes Perfect Complements Eamples that do not meet our assumptions Bads (But, we can turn a bad into a good ) Satiation Perfect Substitutes Tastes: If consumer alwas regards commodities 1 and 2 as equivalent, then commodities are Perfect Substitutes. Onl total amount of two commodities in bundles determines their preference rank-order. Indifference Curves: Straight Lines Eample Brand-Name v. Generic Flour Econ Consumer Preferences 11 Econ Consumer Preferences 12 3

4 Perfect Complements Tastes: If consumer alwas consumes commodities 1 and 2 in fied proportions, Then, commodities are Perfect Complements. Onl number of pairs of two commodities determines preference rank-order of bundles. Indifference Curves: L-Shaped Indifference curves Eample Coffee and sugar Discrete Goods A commodit is infinitel divisible if it can be acquired in an quantit (water, cheese). A commodit is discrete if it comes in indivisible (cars, refrigerators). Indifference curves for discrete goods Suppose commodit 1 is infinitel divisible (gas) Suppose commodit 2 is discrete (cars) Econ Consumer Preferences 13 Econ Consumer Preferences 14 Marginal Rate of Substitution (MRS) Marginal Rate of Substitution MRS at is slope of indifference curve at d MRS = d 2 1 d d MRS = rate at which the consumer is willing to echange commodit 2 for a small amount of commodit 1. Econ Consumer Preferences 15 Econ Consumer Preferences 16 4

5 MRS and Indifference Curves Two goods: IC has negative slope I.e., MRS < 0 If (and onl if) prefs. are strictl conve: MRS alwas increases with (becomes less negative) MRS decreases (becomes more negative) as increases nonconve preferences Econ Consumer Preferences 17 5