1. Consumer Preferences and the Concept of Utility
Lecture # 04b
Consumer Preferences and the Concept of Utility
Lecturer: Martin Paredes

2. Outline Definition of Consumer Preferences Indifference Curves
The Marginal Rate of Substitution
The Utility Function
Marginal Utility
Some Special Functional Forms

3. Consumer Preferences
Definition: Consumer Preferences tell us how the consumer would rank any two allotments of goods (also called baskets or bundles), assuming they were available to the consumer at no cost.
Assumptions:
Completeness
Transitiveness
Monotonicity

4. Completeness
Definition: Preferences are complete if the consumer can rank any two baskets of goods.
For any two bundles A and B, the consumer has three possibilities:
Prefer A to B A  B
Prefer B to A B  A
Indifferent between A and B A ~ B

5. Transitiveness
Definition: Preferences are transitive if the consumer makes choices that are consistent with each other
Consider three bundles: A, B, C
Suppose he prefers A to B A  B
Suppose he prefers B to C B  C
Then he must prefer A to C A  C

6. Intransitivity and Age
Age Number of Subjects Intransitive Choices (%)
Adults
Source: See Hirshleifer, Jack and D. Hirshleifer, Price Theory and Applications. Sixth Edition. Prentice Hall: Upper Saddle River, New Jersey

7. Monotonicity
Definition: Preferences are monotonic if a basket with more of one good is preferred to the original basket.
Notes:
Assumes all other goods in basket remain the same
Also called more is better, since having more of one good is better for the consumer.

8. Indifference Curves
Definition: An Indifference Curve is the set of all baskets for which the consumer is indifferent
Definition: An Indifference Map illustrates the set of indifference curves for a particular consumer

9. y
The "Standard Case"
IC1 x

10. y
The "Standard Case"
Preference direction
IC2
IC1 x

11. Properties of Indifference Maps:
Completeness
Each basket lies on only one indifference curve
Monotonicity
Indifference curves have negative slope
Indifference curves are not “thick”

12. y
Monotonicity • A x

13. y
Monotonicity
Preferred to A • A x

14. y
Monotonicity
Preferred to A • A
Less
preferred x

15. y
Monotonicity
Preferred to A • A
Less
preferred
IC1 x

16. Indifference Curves are NOT Thicky
Indifference Curves are NOT Thick B • • A
IC1 x

17. Properties of Indifference Maps:
3. Transitivity
Indifference curves do not cross
4. Averages preferred to extremes
Indifference curves are bowed toward the origin (convex to the origin).

18. Indifference Curves Cannot Crossy
Indifference Curves Cannot Cross
Suppose a consumer is indifferent between A and C
Suppose that B preferred to A.
IC1 • B • A C • x

19. Indifference Curves Cannot Crossy
Indifference Curves Cannot Cross
It cannot be the case that an IC contains both B and C
Why? because, by definition of IC the consumer is:
Indifferent between A & C
Indifferent between B & C
Hence he should be indifferent between A & B (by transitivity).
=> Contradiction.
IC2
IC1 • B • A C • x

20. Averages Preferred to Extremesy
Averages Preferred to Extremes A • •
IC1 B x

21. Averages Preferred to Extremesy
Averages Preferred to Extremes A •
(.5A, .5B) • •
IC1 B x

22. Averages Preferred to Extremesy
Averages Preferred to Extremes A •
(.5A, .5B) •
IC2 •
IC1 B x