chapter 3: Preferences Flashcards
Consumer preferences
In the problem of choosing the best bundle of goods that a consumer can afford, preferences (or tastes) define the meaning of best.
-Preferences refer to an consumer’s ability to compare or rank one consumption bundle (i.e. a list of goods and services) over another.
weakly preferred set
A weakly preferred set are all the consumption bundles that are at least as good as bundle (x1, x2).
An indifference curve
An indifference curve through a consumption bundle consists of all bundles of goods that leave the consumer indifferent to the given bundle
perfect substitutes
Two goods are perfect substitutes if the consumer is willing to substitute one good for the other at a constant rate.
Perfect complements
Perfect complements are goods that are always consumed together in fixed proportions.
- Indifference curves are L shaped
- Increasing the amount of both goods will move the consumer to a more preferred position.
- Example: right and left shoes; coffee and sugar
A bad
A bad is a commodity that the consumer doesn’t like.
- To compensate for the bad, the consumer needs more of the other good.
- Indifference curves slope up and to the right
- Example: anchovies and pepperoni on pizza with anchovies as a bad
Neutrals
A good is a neutral good if the consumer doesn’t care about it and is always indifferent to increasing amounts.
- Indifference curves are depicted as horizontal or vertical lines
- Example: anchovies as a neutral good
Satiation
Sometimes we want to consider a situation involving satiation where there is some overall best bundle for the consumer (¯x1, x¯2). The best point or satiation point is (¯x1, x¯2). When he consumes too much of a good, it becomes a bad.
People would not voluntarily choose to have too much of the goods they consume. Thus the interesting region from the viewpoint of economic choice is where you have less than you want of both goods.
Discrete goods
A discrete good is a good that is only available in integer amounts (for example cars). In this case, the bundles indifferent to a given bundle will be a set of discrete points.
convex set.
- A convex set has the property that if you take any two points in the set and draw the line segment connecting those two points, that line segment lies entirely in the set
Strict convexity
Strict convexity implies that the weighted average of two indifferent bundles is strictly preferred to the two extreme bundles.
- Convex preferences may have flat spots, while strictly convex preferences must have indifference curves that are rounded. The preferences for goods that are perfect substitutes are convex, but not
strictly convex.
The marginal rate of substitution
The marginal rate of substitution MRS is the slope of an indifference curve. It measures the rate at which the consumer is just willing to substitute one good for the other.
The MRS can also be interpreted as the marginal willingness to pay.
MRS of good 2 forgood 1 is how many euros you would just be willing to give up spending onother goods in order to consume a little bit more of good 1.
Preference relations are ordinal relations.
They state only the order in which
bundles are preferred.
Preference relations are interrelated:
* (x1, x2) (y1, y2) ⇔ (x1, x2)> =(y1, y2) but not (y1, y2) >= (x1, x2)
* (x1, x2) ∼ (y1, y2) ⇔ (x1, x2)>=(y1, y2) and (y1, y2) >= (x1, x2)
Which assumptions on preferences are necessary to be able to determine the
best choice.
A1: Completeness:
* Any two different bundles can be compared.
* Given any x-bundle and any y-bundle, either (x1, x2) >= (y1, y2) or (y1, y2) >= (x1, x2), or both.
A2: Transitivity
* If (x1, x2) >=(y1, y2) and (y1, y2) >= (z1, z2), then (x1, x2) >= (z1, z2).
Monotonicity
If (x1, x2) is a bundle of goods and (y1, y2) is a bundle of goods with at least as
much of both goods and more of one, then (y1, y2) > (x1, x2).
We restrict attention to only goods and exclude bads and assume that more is
better.
This implies that indifference curves always have a negative slope.
