11/08/2015

Consumer Theory (Consumers preferences and

choices)
In economics and other social sciences,
preference is the ordering of alternatives based on
their relative utility, a process that results in an optimal "choice" (whether
real or theoretical).
The character of the individual preferences is determined purely by
taste factors, independent of considerations of prices, income, or availability
of goods.
With the help of the scientific method many practical decisions of life
can be modeled, resulting in testable predictions about human behavior.
Although economists are usually not interested in the underlying causes of
the preferences in themselves, they are interested in the theory of choice
because it serves as a background for empirical demand analysis.

Notation:
Suppose the set of all states of the world is
and an agent has a
preference relation on .
It is common to mark the weak preference relation by , so that
means "the agent wants y at least as much as x" or "the agent weakly
prefers y to x".
The symbol

is used as a shorthand to the indifference relation:

, which reads "the agent is indifferent between

y and x".
The symbol

is used as a shorthand to the strong preference relation:

, which reads "the agent strictly prefers y to x".

Meaning in decision sciences

In everyday speech, the statement "x is preferred to y" is generally

understood to mean that someone chooses x over y. However, decision
theory rests on more precise definitions of preferences given that there are

many experimental conditions influencing people's choices in many

directions.
Suppose a person is confronted with a mental experiment that she must
solve with the aid of introspection. She is offered apples (x) and oranges (y),
and is asked to verbally choose one of the two. A decision scientist
observing this single event would be inclined to say that whichever is chosen
is the preferred alternative.
Under several repetitions of this experiment (and assuming laboratory
conditions controlling outside factors), if the scientist observes that apples
are chosen 51% of the time it would mean that
. If half of the time
oranges are chosen, then
. Finally, if 51% of the time she chooses
oranges it means that
. Preference is here being identified with a
greater frequency of choice.
This experiment implicitly assumes that the trichotomy property holds for the
order relation. Otherwise, out of 100 repetitions, some of them will give as a
result that neither apples, oranges nor ties are chosen. These few cases of
uncertainty will ruin any preference information resulting from the frequency
attributes of the other valid cases.
However, this example was used for only illustrative purposes, and it should
not be interpreted as an indication that the economic theory of preferences
starts with experiments and moves on to theorems. On the contrary, the
method used in the theory preferences is essentially an armchair method.
Economists make assumptions, and from these assumptions they deduce
theorems which presumably can be tested, even though the test is not
indispensable.
Consumers are by definition demanders of goods and services. Standard
economic theory states that their demand behavior can be thought of
maximizing a utility index, or its parallel: the the binary relation "at least as
good as" or the relation "strictly preferred as".

Of all the available bundles of goods and services, only one is ultimately
chosen. The theory of preferences examines the problem of getting to this
optimal choice using a system of preferences within a budgetary limitation.
In reality, people do not necessarily rank or order their preferences in a
consistent way. In preference theory, some idealized conditions are regularly
imposed on the preferences of economic actors. One of the most important
of these idealized conditions is the axiom of transitivity.
Axiom of transitivity:
If alternative is preferred to alternative
preferred to .

, and

to

, then

is

Symbolically, this can be stated as

If

and

then

The language of binary relations allow one to write down exactly what is
meant by "ranked set of preferences", and thus gives an unambiguous
definition of order. A preference relation should not be confused with the
order relation used to indicate which of two real numbers is greater. [6]
Order relations over the real number line satisfy an extra condition:
and
implies
But in preference relations, two things can be equally liked without being in
some sense numerically equal. Hence, an indifference relation is used
instead of an equality relation (the symbol
denotes this kind of relation).
Thus we have
and
implies
A system of preferences or preference structure refers to the set of
qualitative relations between different alternatives of consumption. For
example, if the alternatives are:
Apple

Orange
Banana
In this example, a preference structure would be:
"The apple is at least as preferred as the orange", and "The orange is as
least as preferred as the Banana". One can use to symbolize that some
alternative is "at least as preferred as" another one, which is just a binary
relation on the set of alternatives. Therefore:
Apple Orange
Orange Banana
The former qualitative relation can be preserved when mapped into a
numerical structure, if we impose certain desirable properties over the binary
relation: these are the axioms of preference order. For instance: Let us take
the apple and assign it the arbitrary number 5. Then take the orange and let
us assign it a value lower than 5, since the orange is less preferred than the
apple. If this procedure is extended to the banana, one may prove by
induction that if is defined on {apple, orange} and it represents a welldefined binary relation called "at least as preferred as" on this set, then it
can be extended to a function defined on {apple, orange, banana} and it
will represent "at least as preferred as" on this larger set.
Example:
Apple = 5
Orange = 3
Banana = 2
5 > 3 > 2 = u(apple) > u(orange) > u(banana)
and this is consistent with Apple Orange, and with Orange Banana.
Axiom of order (Completeness):
For all and
we have
or
or both.
In order for preference theory to be useful mathematically, we need to
assume the axiom of continuity. Continuity simply means that there are no
jumps in peoples preferences. In mathematical terms, if we prefer point A
along a preference curve to point B, points very close to A will also be
preferred to B. This allows preference curves to be differentiated. The
continuity assumption is "stronger than needed" in the sense that it indeed
guarantees the existence of a continuous utility function representation.

Continuity is, therefore, a sufficient condition, but not a necessary one, for a
system of preferences.[7]
Although commodity bundles come in discrete packages, economists treat
their units as a continuum, because very little is gained from recognizing
their discrete nature. According to Silberberg,[citation needed] the two approaches
are reconcilable by this rhetorical device: When a consumer makes repeated
purchases of a product, the commodity spaces can get converted from the
discrete items to the time rates of consumption. Instead of, say, noting that a
consumer purchased one loaf of bread on Monday, another on Friday and
another the following Tuesday, we can speak of an average rate of
consumption of bread equal to 7/4 loaves per week. There is no reason why
the average consumption per week cannot be any real number, thus
allowing differentiability of the consumer's utility function. We can speak of
continuous services of goods, even if the goods themselves are purchased
in discrete units.
Although some authors include reflexivity as one of the axioms required to
obtain representability (this axiom states that
), it is redundant
inasmuch as the completeness axiom implies it already.

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