Lecture 10slide 1 A primer on Consumer Choice Preferences, Indifference Curves and Utility

Lecture 10slide 2 INTRODUCTION Preferences Indifference Curves Utility

Lecture 10slide 3 The problem Simplify the consumer’s choice problem into her making the best she can to maximize her satisfaction

Lecture 10slide 4 Preferences What is best? We assume that what is best for the consumer should be left to her to decide (we want to be positive, not normative) And that her preferences, how much she enjoys the consumption of goods can be described by using indifference maps

Lecture 10slide 5 Preferences Define a consumption bundle (or basket) as a combination of quantities of different goods (for simplicity 2 goods) Say we use goods X and Y so the basket is (x,y)

Lecture 10slide 6 Properties of Preferences We assume preferences to be: complete: any bundle (x,y) can be compared to any other bundle (x’,y’), the consumer can rank them or know that she is indifferent between both This might seem rational…but not always, …like when you are 4 years old and your brother is 5 or so :)

Lecture 10slide 7 Properties of Preferences We assume preferences to be: transitive: if (x,y) is weakly preferred to (x’,y’) and (x’,y’) is weakly preferred to (x”,y”) then the consumer must weakly prefer (x,y) to (x”,y”)

Lecture 10slide 8 Properties of Preferences We assume preferences to respect the non- satiation property (for the case of goods) or free disposability

Lecture 10slide 9 Indifferences curves We can represent the preferences of consumers by using indifference curves These show in the x, y space those consumption bundles about which the consumer is indifferent Indifference curve: combinations of goods that give the same level of satisfaction We are going to think of X and Y as pizzas and burritos and of x and y as pizzas per semester and burritos per semester

Lecture 10slide 10 Indifferences curves Using the property of nonsatiation, we can work out the green area of preferred bundles and the orange area of dominated bundles

Lecture 10slide 11 Indifferences curves The indifference curve passing through e might well look like this (it respects the nonsatiation property)

Lecture 10slide 12 Indifferences curves The further from the origin, the more utility the indifference curves show y x Better

Lecture 10slide 13 Indifferences curves There is an indifference curve through all possible bundles y x

Lecture 10slide 14 Indifferences curves Indifference curves cannot cross! y x e b a

Lecture 10slide 15 Indifferences curves Indifference curves cannot be any thick! y x e b

Lecture 10slide 16 Indifferences curves Indifference curves for goods should slope downwards y x e b

Lecture 10slide 17 Marginal Rate of Substitution Indifference curves tell us about the willingness of the consumer to substitute one good for the other y x e b

Lecture 10slide 18 Marginal Rate of Substitution The Marginal Rate of Substitution is the maximum amount of one good the consumer is willing to sacrifice to obtain a marginal unit of the other good y x e b MRS is the slope of the indifference curve

Lecture 10slide 19 The curvature of indifference curves Most indifference curves are convex to the origin, exhibiting decreasing MRS between the goods y x e b

Lecture 10slide 20 The curvature of indifference curves But other possibilities exist: concave curves (increasing MRS!!!) => you prefer the extremes to the mixing, perhaps you hate the combination of both goods! Or they are individually addictive… y x e b Ice-cream anchovies

Lecture 10slide 21 The curvature of indifference curves But other possibilities exist: straight lines => what kind of preferences do they represent? y x e b

Lecture 10slide 22 The curvature of indifference curves Check the slope…constant what does it show? y x e b Go to hidden slidehidden slide

Lecture 10slide 23 The curvature of indifference curves Check the slope…constant what does it show? The rate of substitutability!!! y x e b Cokes Pepsis

Lecture 10slide 24 The curvature of indifference curves What about this slope? y x e b Go to hidden slide

Lecture 10slide 25 The curvature of indifference curves What about this slope? y x e b 1 litre cokes 0.5 litre pepsis

Lecture 10slide 26 The curvature of indifference curves What about this shape? y x e b Go to hidden slide

Lecture 10slide 27 The curvature of indifference curves What about this shape? Think about left-foot shoes and right foot shoes for two-footed people y x e b

Lecture 10slide 28 The curvature of indifference curves These goods have A different complementarily ratio Sugarcubes Tea cups e b

Lecture 10slide 29 The curvature of indifference curves What about this shape? Could happen with food and clothes y x

Lecture 10slide 30 Next Utility and Budget Constraints