Consumer Choice: Preferences

Question 1

Preference notations (3)

Answer 1

A>B A is strictly preferred
A~B indifferent to B
A>=B weakly preferred (equally good)

Question 2

4 assumptions to give CONSISTENT PREFERENCES

Answer 2

Completeness - Bundles can be compared.
Reflectivity - Any bundle is at least as good as itself
Transitivity- if A>B and B>C then A>C

Consumer makes rational choices

Question 3

Why is consistency needed?

Answer 3

Difficult to build model.

Question 4

What additional assumption is often made?

Answer 4

Monotonicity/Nonsatiation - more is always better

Question 5

Self regarding vs other-regarding preferences

Answer 5

Self regarding - only concerned with outcomes we experience

Other-regarding - also concerned with outcomes of others.

Question 6

Indifference curve

Answer 6

Shows all combinations of bundles between which the consumer is indifferent. (Provide same level utility)

Question 7

Can indifference curves cross?

Answer 7

No, as we assume Transitivity. If they intersect it is wrong as that would infer same utility, and they are not on the same indifference curve!

Question 8

3 properties of well-behaved indifference curves

Answer 8

Monotonicity/nonsatiation
Convexity - diversity is preferred (e.g 5 apples 5 bananas vs 10 apples)
Continuity - a small change in consumption results in small change in utility

Question 9

Key concept for convexity - diversity is preferred: pg 47 hard.

Equation.

Answer 9

Averages are preferred to extremes.

(tx₁+(1-t)y₁, tx₂+(1-t)y₂ >= (x₁,x₂)
t is the weight assinged to the good between 0-1.
If expression is true, then it is convex, needed for well behaved preferences.

Nonconvex and concave preferences don’t accept convexity, since the averaged bundle is always under the original curve (less utility)

Question 10

Example
2 bundles A and B
A= (100;10) B=(10:100) A~B

1. Will consumer prefer bundle X (120,10) to bundle B?
2. Will consumer prefer bundle Y with Y=10,90 to bundle A?
3. What about Z=55:55?

Answer 10

1. Yes, monotonicity (130>110)
2. No, by transitivity and monotonicity. It is not better than B (monotonicity 100>90) , and B is indifferent (~) to A, so bundle Y cannot be preferred to A.
3. Same amount as A and B, so need to check convexity. We need a t between 0-1.
   Look at both goods separately. Good 1 first….

Use formula tA + (1-t)B , if = Z, Z preferred to A&B.
Quantity of good 1 in A=100, and B=10… so
t x 100 + (1-t)10 =55
100t + 10 - 10t=55
t=0.5

Now do for 2nd good to see if same coefficient (t=0.5 is valid - done workings on goodnotes)
Quantity of good 2 in A=10 B=100
0.5(10) + (1-0.5)100=55 which is Z!!!

So it is preferred!!!

Question 11

Well behaved preferences may not be realistic due to the assumption of continuity. Evaluation of continuity

Answer 11

If goods only come in whole units there cannot be continuity. E.g buying a car.

Question 12

What does a perfect substitute look like on indifference curve

Answer 12

Constant rate of substitution, so slope is constant.

Question 13

What do perfect complements look like on indifference curve?

Answer 13

L SHAPE - consumed together in a fixed proportion. E.g left and right shoes. (Just like fixed proportion isoquant)

Question 14

What do bads look like on indifference curves (assume good Y to be the bad good)

Answer 14

A bad is a good consumers doesn’t like (negative utility)

ASSUMING Y IS A BAD GOOD AND X IS STANDARD,

Question 15

What assumption is violated by bads

Answer 15

Monotonicity - as we don’t want more BADS

Question 16

What do neutrals look like on indifference curve

Answer 16

Give 0 utility. So vertical lines as utility only increases when the consumption of the standard good increases.

Question 17

What does satiated preferences look like (pg53)

Answer 17

There is an overall best bundle for the consumer.

The further away, the worse off they are.

Shown by a point on the graph. (Bliss point)

Question 18

What assumption does satiated preferences violate

Answer 18

Monotonicity.

E.g don’t want music tooo loud, we want it at a certain level. More is not always better than less in this model.

Thus satiated preferences are more realistic

Question 19

What do discrete goods look like (pg54)

Answer 19

Good X only consumed in integers, has to be a linear line for indifference curves. (Dotted lines in between the discrete values - acts as a hypothetical indifference curve since we cannot consume non-discrete values in reality)

Question 20

MRS definition and formula.

Answer 20

Rate willing to trade good Y for good X. Essentially WTP!!

Eg X=20 Y=10
MRS = -2 (2Ys to replace X)

Change in Y/Change in X

Question 21

MRS for perfect subs, neutrals, perfect complements, and strictly convex curves

Answer 21

Perfect subs -Constant (e.g if one for one, slope -1)
Neutrals - infinite
Perfect complements - 0 or infinity.

Strictly convex indifference curves - MRS is diminishing.

Question 22

What happens as your move down an indifference curve

Answer 22

Experience a diminishing MRS (Slope gets flatter)
When u have a lot, more willing to give it up for an additional unit of the other one. When u have limited, less willing to give up.

Question 23

MRS as exchange rate

Answer 23

If she gives up ∆x of good 1 then she can obtain E∆x units of good 2.

Slope is -E