PREFERENCES

Chapter 3

Learning goals for today

Understanding common assumptions of

consumer preferences
Representing a preference set through
indifference curves
Going through examples dealing with
consumer preferences

Consumer Preferences

Consumption bundles are lists of goods and

services that the consumer makes a choice
about how much to consume.
Consider a simple example in which a
consumer consumes 2 apples and 5
bananas:

The consumption bundle (xa,xb) is (2,5).

xa = amount of apples consumed

xb = amount of bananas consumed

The Commodity Plane

Graphical representation of 2 apples, 5 bananas

Bananas (xb)

(2, 5)

Apples (xa)
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Multiple Commodities

Two goods represented as

Ordered pair (x1,x2) in commodity plain

Often sufficient for thinking about trade-offs, ceteris

paribus. But sometimes we need more.

What about 3 goods?

Ordered triple (x1,x2,x3) in commodity 3-space

(x1,x2,x3)

What about n goods?

Ordered n-tuple (x1,x2, , xn) in commodity n-space

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Consumer Preferences

Preferences describe how consumers rank

different consumption bundles
Given any two consumption bundles, (x1,x2)
and (y1,y2), the consumer can tell us whether
he strictly prefers one to the other: (x1,x2) f (y1,y2)
or
he is indifferent between the bundles: (x1,x2) (y1,y2)
or
f
he weakly prefers one to the other: (x1,x2) ~ (y1,y2)

Helpful Notation

Strictly prefers f
(also written >)
Indifferent

f
Weakly prefers
(also
written )
~
Examples

1 apple and 1 orange 2 apples

2 apples now f 2 apples tomorrow

Flows vs. stocks

We will more often be concerned with flows (2

apples per week)
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Consumer Preferences
Note:
1. If (x1,x2) f (y1,y2) and (y1,y2) f(x1,x2),
~

then (x1,x2)~(y1,y2)

2. If (x1,x2) ~f (y1,y2) but we also know that

(x1,x2)~(y1,y2) is not true, then (x1,x2)f(y1,y2)

Assumptions about
Preferences

Completeness
. Any two bundles can be compared
1.

(x1,x2) f (y1,y2) or
~
(y1,y2) f (x1,x2) or
~

both, in which case the consumer is indifferent

Reflexivity
. Any bundle is at least as good as itself
2.

(x1,x2) ~f (x1,x2)
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Assumptions about
Preferences
Transitivity
. If (x ,x ) f (y ,y ) and (y ,y ) f(z ,z ),
1 2 ~
1 2
1 2 ~ 1 2
3.

then (x1,x2) ~f (z1,z2)

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Question
Is it reasonable to have a situation where
(x1,x2) f (y1,y2) and (y1,y2) f (x1,x2)?
a)
b)
c)

Yes
No
I am indifferent between a) and b)

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Indifference Curves

Indifference curves are graphical

representations of preferences.
We can draw an indifference curve (IDC)
through any consumption bundle we want
The IDC through a consumption bundle
consists of all bundles of goods that leave the
consumer indifferent to the given bundle

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Indifference Curves
x2

Weakly Preferred Set

x2

IDC-bundles
indifferent to
(x1,x2)
x1

x1
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Indifference Curves

If we make no further assumptions about

preferences, the IDCs can take peculiar
shapes
But even at this level of generality, we can
state an important principle of IDCs:

IDCs represent distinct levels of preference and

therefore cannot cross

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Indifference Curves
x2

The diagram shows us that:

x~z & z~y x~y
which is clearly not the case

x1
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Question

Is A preferred to B?

a)
b)
c)

Yes
No
Makes no sense

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Question

Can indifference curves

cross?
a)

b)

Yes, intersecting
indifference curves do
not violate any of the
assumptions about
preferences
No, intersecting
indifference curves
violate assumptions
about preferences

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Examples of preferences
1.
2.
3.
4.
5.
6.

Perfect Substitutes
Perfect Complements
Bads
Neutrals
Satiation
Discrete Goods

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1. Perfect Substitutes

x2

Two goods are perfect substitutes if the

consumer is willing to substitute one good for
the other at a constant rate
Diagram A

x2

Diagram B

IDC
Slope = -2

IDC
Slope = -1

x1

x1
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1. Perfect Substitutes

IDCs have a constant slope

Different goods have different rates of
substitution:

Want one of good 2 to give up one unit of good 1

to remain equally happy (diagram a)
Want two of good 2 to give up one unit of good 1
to remain equally happy (diagram b)

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2. Perfect Complements

L-shaped indifference curves

Complements are consumed in fixed
proportions, but not necessarily at a one to
one rate

2 spoons of sugar to 1 cup of coffee

1 part Jack Daniels Whiskey to 3 parts Coca-Cola

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2. Perfect Complements

Goods that are always consumed together in

fixed proportions are perfect complements
e.g. Right and left shoes

Left
shoes

Right
shoes
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More on preferences next

time

Make sure to learn the first two examples we

did today
This may help in learning the other examples
we cover in the next lecture

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Important learning points

Indifference curves tell us ordering of

preferences

Make sure to know how to solve different kinds of

problems dealing with preferences

Coming soon

We will combine budget constraint and preference

concepts to solve constrained optimization
problems

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