Lecture 4 - Preferences

Question 1

What is a good?

Answer 1

A good can be anything a consumer values, not just consumption goods

Question 2

Do economists judge whether an individual’s preferences are sensible?

Answer 2

Economists do not judge whether an individual’s preferences are sensible, they only aim at describing them

Question 3

Write a statement using the correct notation stating that a consumer weakly prefers good a to good b

Answer 3

a b if the consumer weakly prefers a to b (‘a is at least as good as b’)
Check lecture 4 slides to confirm the symbols

Question 4

What is another way of saying that a consumer weakly prefers good a to good b?

Answer 4

Good a is at least as good as good b

Question 5

Write a statement using the correct notation showing that a consumer strictly prefers good a to good b

Answer 5

a b if the consumer strictly prefers a to b.
* Check lecture 4 slides to see the correct symbol*

Question 6

Write a statement using the correct notation showing that a consumer is indifferent between good a and good b

Answer 6

a ~ b if the consumer is indifferent between a and b

Question 7

What are the 3 assumptions made about preferences also known as?

Answer 7

The axioms of consumption theory

Question 8

State the 3 assumptions made about preferences

Answer 8

1- Completeness: When facing a choice between two bundles of goods, a consumer can rank them so that either: they weakly prefer a to b, they weakly prefer b to a or they are indifferent between a and b
2- Transitivity: Consumer’s rankings are logically consistent in the sense that if they weakly prefer a to b and they weakly prefer b to c, then they also weakly prefer a to c
3- Non-Satiation: All else equal, more of a good is better than less

Question 9

Are wealthier people on average happier than poorer people?

Answer 9

Using data from many countries, Stevenson and Wolfers (2013) found no evidence of a satiation point beyond which wealthier individuals have no further increases in subjective well-being

Question 10

What do the 3 assumptions of preferences allow?

Answer 10

They allow for convenient graphical and mathematical representations of preferences

Question 11

What type of goods form an indifference curve?

Answer 11

Equally desirable bundles of goods form an indifference curve

Question 12

What is a collection of indifference curves called?

Answer 12

A collection of indifference curves is called an indifference map

Question 13

What are the 5 properties/rules for indifference curves derived from the 3 preferences assumptions?

Answer 13

1- Bundles on indifference curves further from the origin are preferred to those on indifference curves closer to the origin
2- Every bundle lies on an indifference curve
3- Indifference curves cannot cross
4- Indifference curves cannot slope upwards
5- Indifference curves cannot be thick

Question 14

What are the axes of an indifference curve labelled as?

Answer 14

The axes of an indifference curve/map are the two goods in question that are equally desirable

Question 15

How does the satisfaction gained at different points on an indifference curve change at different points?

Answer 15

All the different points on an indifference curve mean that the user gets the same satisfaction at each of the points (indifference)

Question 16

What does it mean if an indifference curve is a horizontal line?

Answer 16

If an indifference curve is a horizontal line this means that the user is indifferent about the good on the x-axis as at all points of consumption of the good on the x-axis the user gets the same amount of utility

Question 17

What is given by the slope/gradient of an indifference curve?

Answer 17

• The slope of an indifference curve shows the rate at which a consumer is willing to trade one good for another
• The slope (gradient) of an indifference curve measures the marginal rate of substitution (MRS) between the two goods in question

Question 18

How do we calculate the marginal rate of substitution from an indifference curve?

Answer 18

MRS is calculated by drawing a tangent at the desired point on the indifference curve and calculating the gradient at that point to find the marginal rate of substitution. This can be a negative number as indifference curves slope downwards

Question 19

What is the marginal rate of substitution?

Answer 19

The marginal rate of substitution is a measure of how many of one good you are willing to give up to get more of the other good

Question 20

What is the central assumption of consumer theory/preferences?

Answer 20

Transitivity is the central assumption of consumer theory

Question 21

What is some evidence to back up the theory of transitivity demonstrating that people make consistent choices?

Answer 21

Weinstein (1968): experimental subjects chose between 10 good, offered in all pair-wise combinations

Bradbury and Ross (1990): give choice of pairwise combinations of three colours, faces and photos etc.

Question 22

How do economists use the concept of preferences?

Answer 22

Economists use the concept of preferences (‘tastes’) to model how consumers rank the desirability of the goods available to them