Preferences,

Revealed
Preferences,
and Utility

Topic 2:
Preferences, Revealed Preferences, and Utility

Preferences
Preference
Maximizing
Choice
The Rational
Economic Agent
Revealed
Preferences

No textbook references.

Utility

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Preferences,
Revealed
Preferences,
and Utility

Preferences

The two main ideas of economics:

Preference
Maximizing
Choice
The Rational
Economic Agent

Rationality.

Equilibrium.

Revealed
Preferences
Utility

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Preferences,
Revealed
Preferences,
and Utility

Preferences

Consider two dinners: a beef burger with fries, and stir fried
vegetables with rice. Which one do you prefer?

Preference
Maximizing
Choice
The Rational
Economic Agent

 beef burger with fries,

Revealed
Preferences

 stir fried vegetables with rice,

Utility

 both are the same for me.

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Consider two dinners: a beef burger with fries, and stir fried
vegetables with rice. Which one do you prefer?

Preferences,
Revealed
Preferences,
and Utility

Preferences

 beef burger with fries,

2
 stir fried vegetables with rice,

 both are the same for me.

Preference
Maximizing
Choice
The Rational
Economic Agent
Revealed
Preferences

We write:

Utility

stir fried vegetables with rice  beef burger with fries.

Read:
stir fried vegetables with rice are strictly preferred to beef
burger with fries.

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The other possible answers:

Preferences,
Revealed
Preferences,
and Utility

beef burger with fries  stir fried vegetables with rice

Preferences

Read:
beef burger with fries is strictly preferred to stir fried
vegetables with rice.

Preference
Maximizing
Choice
The Rational
Economic Agent
Revealed
Preferences
Utility

beef burger with fries stir fried vegetables with rice

Read:
the agent is indifferent between beef burger with fries and
stir fried vegetables with rice.

5 / 19

Preferences,
Revealed
Preferences,
and Utility

Suppose X is the set of possible dinners: x, y , z, . . .

Definition: A preference is a complete list of answers to our
questionnaire about pairwise comparisons.That is, for every
pair x, y in X :
I

x  y or

y  x or

x y.

Preferences
Preference
Maximizing
Choice
The Rational
Economic Agent
Revealed
Preferences
Utility

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Assumptions about Preferences

I

No contradictions:
I
I

Preferences,
Revealed
Preferences,
and Utility

If x y then y x.
If x  y then not y  x.

Preferences
Preference
Maximizing
Choice
The Rational
Economic Agent

Transitivity:
I
I
I
I

If
If
If
If

x
x
x
x

y
y
y
y

and
and
and
and

y
y
y
y

z
z
z
z

then
then
then
then

x
x
x
x

 z.
 z.
 z.
z.

Revealed
Preferences
Utility

We assume that people have contradiction free and transitive

preferences.
To simplify we assume that we never have: x y if x 6= y .
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Preference Maximizing Choice

Suppose you are given a menu:

X = {x1 , x2 , . . . , xn }

Preferences,
Revealed
Preferences,
and Utility

Preferences
Preference
Maximizing
Choice
The Rational
Economic Agent

of n possible dinners.

Revealed
Preferences

Suppose your choice is: xi .

Utility

Your choice maximizes your preference if:

xi  x
for all other options x in X .

8 / 19

The Rational Economic Agent

Preferences,
Revealed
Preferences,
and Utility

Preferences

The rational economic agent:

Preference
Maximizing
Choice

has contradiction-free, transitive preferences,

The Rational
Economic Agent

always makes preference maximizing choices.

Revealed
Preferences
Utility

Note: Any contradiction-free, transitive preferences are

allowed.

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Revealed Preferences
Suppose:
I
I

I know you are a rational economic agent;

I observe you choose
I
I

x from {x, y };
z from {x, z}.

Preferences,
Revealed
Preferences,
and Utility

Preferences
Preference
Maximizing
Choice
The Rational
Economic Agent
Revealed
Preferences

What can I infer about your preferences?

I

x  y and z  x;

because your preferences are transitive: z  y ;

because your preferences are contradiction-free: x x,

y y , and z z.

Utility

You have revealed your preference through your choices.

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Revealed Preferences
Suppose:
I
I

I know you are a rational economic agent;

I observe you choose
I
I

x from {x, y };
x from {x, z}.

Preferences,
Revealed
Preferences,
and Utility

Preferences
Preference
Maximizing
Choice
The Rational
Economic Agent
Revealed
Preferences

What can I infer about your preferences?

I

x  y and x  z;

Because your preferences are contradiction-free: x x,

y y , and z z;

But: I dont know whether y  z, z  y or y z.

Utility

Your choices have revealed your preferences incompletely.

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Revealed Irrationality

Preferences,
Revealed
Preferences,
and Utility

Suppose:
I
I

I think you are a rational economic agent;

I observe you choose
I
I

x from {x, y };
y from {x, y , z}.

Preferences
Preference
Maximizing
Choice
The Rational
Economic Agent
Revealed
Preferences

What can I infer about your preferences?

I

x  y and y  x?

This is not contradiction free.

Utility

Your choices have revealed that you are not a rational

economic agent.
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Revealed Irrationality

Preferences,
Revealed
Preferences,
and Utility

Suppose:
I
I

I think you are a rational economic agent;

I observe you choose
I
I
I

x from {x, y };
y from {y , z};
z from {x, z}.

Preferences
Preference
Maximizing
Choice
The Rational
Economic Agent
Revealed
Preferences
Utility

What can I infer about your preferences?

I

x  y and y  z and z  x?

This is not transitive.

Your choices have revealed that you are not a rational

economic agent.
13 / 19

Preferences,
Revealed
Preferences,
and Utility

Preferences

Which conditions do observed choices have to satisfy so that

they may have been made by a rational economic agent?

Preference
Maximizing
Choice
The Rational
Economic Agent
Revealed
Preferences
Utility

The Axioms of Revealed Preferences.

14 / 19

Preferences,
Revealed
Preferences,
and Utility

Observed choices satisfy the Weak Axiom of Revealed

Preferences (WARP) if for all pairs of options x and y :

If x was chosen when y was also available,

then
I

Preferences
Preference
Maximizing
Choice
The Rational
Economic Agent
Revealed
Preferences
Utility

y was never chosen when also x was available.

A rational economic agent will satisfy WARP.

15 / 19

Preferences,
Revealed
Preferences,
and Utility

Preferences

A violation of WARP:

Preference
Maximizing
Choice
The Rational
Economic Agent

I observe you choose

I
I

x from {x, y };
y from {x, y , z}.

Revealed
Preferences
Utility

16 / 19

Utility
Sometimes it is convenient to represent a preference by a
utility function.

Preferences,
Revealed
Preferences,
and Utility

Preferences

If
a  b and b  c and c  d,
then a utility function that represents this preference is:
u(a) = 5, u(b) = 4, u(c) = 3, u(d) = 2,

Preference
Maximizing
Choice
The Rational
Economic Agent
Revealed
Preferences
Utility

and also
u(a) = 25, u(b) = 16, u(c) = 9, u(d) = 4,
and also
u(a) = 2.5, u(b) = 2, u(c) = 1.5, u(d) = 1.
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Preferences,
Revealed
Preferences,
and Utility

Preferences

Preferences can be represented by many utility functions.

Preference
Maximizing
Choice
The Rational
Economic Agent

If one utility functions represents a preference then also all

strictly increasing transformations of this utility function
represent the same preference.

Revealed
Preferences
Utility

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The Four Laws of Utility Theory

Preferences,
Revealed
Preferences,
and Utility

Preferences

Utility numbers have no meaning.

Preference
Maximizing
Choice
The Rational
Economic Agent

Only the comparison of utility numbers has meaning.

Revealed
Preferences
Utility

Utility is not happiness.

Utility is not Dollars.

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