Motivation for understanding consumer preferences:
Motivation: (1) options and (2) objectives consumers persue
“Objective” Preferences:
- Preferences Relation: How consumers rank options
- Axioms: Allows construct, compelte, and consistently rank all potential consumption bundles
Define consumer behavior:
Consumer Behavior: people choose the best they can afford → objects of choice are consumer bundles
What are the three preference relations?
Suppose two consumer bundles (x_1, x_2) and (y_1, y_2)
Ranked in order of desirability → (x_1, x_2) succ (y_1, y_2) (consumer (1) strictly prefers the second option)
- Idea that one would be chosen over the other (given the opportunity) is based on consumer behavior
Alternatively they can be (2) indifferent between the two: (x_1, x_2) ~ (y_1, y_2)
- Equally satisfied with both options
Finally, consumer (3) weakly prefers a good when the consumer prefers or is indifferent between two bundles: (x_1, x_2) ⪯ (y_1, y_2)
Above relationships related to each other
Axioms about preferences:
Complete, Reflexive, Transitive
Indifference curves cannot cross because it would violate the idea of transitivity
What is an indifference curve (set)?
For bundle x’, then the set of all bundles equally preferred ⇒ indifference curve (set)
Set of bundles y ~ x’
Shape depends on preferences and infinite amount of indifference curves
- Weakly Preferred Set Shade in all the consuption bundles that are weakly preferred
- Bundles on boundary of this set → just indifferent to (x_1, x_2) ⇒ Indifference Curve
Assumptions for Well-Bahaved indifference curves:
Assumptions:
- Monotonicity Preference: Assumption that more is better
- Convex: Prefer C over A/b
(Averages are preferred to extremes)
What is the marginal rate of substitution and its relation to the slope?
Slope of an indifference Curve: marginal rate of subsitution
Marginal Rate of Subsitution (differential of indifference curve): dx\dy
How many units of one good must be given up to get the other, while maintaing indifference
- Going to be higher at extremes (steeper curve)
- Negative differential: “give up good”
Types of Indifference curves
- Perfect substitutes
- Perfect Complements
- Bads
- Neutrals
Assume that the curves are well-behaving (monotonicity and convex)
Types of Indifference Curves
Perfect Subsitutes:
Perfect Substitutes: consumer willing substitute one good for another at a constant rate
- Indifference curves all straight parallel lines (m=-1) -> slope ⇒ constant
Types of Indifference Curves
Perfect Complements:
Perfect Complements: goods always consumed together in fixed proportions.
- Fixed proportion (not necessarily one-to-one)
- MRS: 0 (no amount good two want to give up → too much of the othe rgood)
Types of Indifference Curves
Bads:
Bad → commodity consumer does not like
Direction of increasing preferences is down and to the right → towards direction of decreasing “bad”
- Positive slope: have to be compensated more of the good to take on more of the bad
Types of Indifference Curves
Neutrals:
Neutrals - indifferent towards any option
