Preferences. Preference Relation The consumer strictly prefers bundle X to bundle Y: The consumer is indifferent between X and Y:

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Presentation transcript:

Preferences

Preference Relation The consumer strictly prefers bundle X to bundle Y: The consumer is indifferent between X and Y:

Weak Preference If or Then:

How are the relations related? Q: What do these two relations imply?

How are the relations related? A: The consumer is indifferent between X and Y:

Assumption I: Complete Preferences For any two bundles X and Y: X preferred to Y: Y preferred to X: Indifference:

Assumption II: Reflexive Any bundle X is at least as good as itself:

Assumption III: Transitive If: And: Then:

Indifference curves Indifference curve Weakly preferred set

Q: Can indifference curves cross?

Perfect substitutes

Perfect complements

Satiation

Well-behaved preferences Let’s impose some extra assumptions to rule out less interesting situations Well-behaved preferences satisfy two properties: 1. Monotonicity 2. Convexity

Monotonicity Consider two bundles: where Y has at least as much of both goods and more of one. Then: Monotonicity implies that indifference curves have negative slopes

Indifference curves have negative slopes

Convexity Consider two bundles: Convexity implies that, for

Convex preferences

Non-convex preferences

Marginal rate of substitution The MRS is the slope of the indifference curve at a point MRS=derivative of indifference curve

Interpretation of MRS The MRS measures the rate at which the consumer is willing to substitute one good for the other. If good 2 is measured in dollars, the MRS measures the consumer’s willingness to pay for an extra unit of good 1.

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