ECN 301
Intermediate
Microeconomics
Instructor: Nabila Maruf
Independent University, Bangladesh
Lecture Note: 3
Chapter 3: Preferences
Preferences
This chapter will be devoted to clarifying the economic
concept of “best things.”
We call the objects of consumer choice consumption bundles.
This is a complete list of the goods and services that are
involved in the choice problem that we are investigating.
When, where and under what circumstances goods become
available is important along with list of goods
3.1 Consumer Preferences
Two Consumption Bundles : (x1, x2) and (y1, y2)
x1 – amount of one good
x2 – amount of another good
y1 – amount of one good
y2 – amount of another good
Consumers can rank the bundles according to their
desirability
3.1 Consumer Preferences
The symbol ≻ to mean that one bundle is strictly
preferred to another
(x1, x2) ≻ (y1, y2) – interpretation is that the consumer
strictly prefers (x1, x2) to (y1, y2), in the sense that she
definitely wants the x-bundle rather than the y-bundle.
If the consumer is indifferent between two bundles of
goods, we use the symbol ∼ and write: (x1, x2) ∼ (y1, y2).
3.1 Consumer Preferences
Indifference means that the consumer would be just
as satisfied, according to her own preferences,
consuming the bundle (x1, x2) as she would be
consuming the other bundle, (y1, y2).
If the consumer prefers or is indifferent between the
two bundles we say that she weakly prefers (x1, x2)
to (y1, y2) and write (x1, x2) ⪰ (y1, y2).
3.2 Assumptions about Preferences
Three Axioms about consumer preference:
Complete We assume that any two bundles can be
compared. That is, given any x-bundle and any y-
bundle, we assume that (x1, x2) ⪰ (y1, y2), or (y1, y2)
⪰ (x1, x2), or both, in which case the consumer is
indifferent between the two bundles.
Reflexive. We assume that any bundle is at least as
good as itself: (x1, x2) ⪰ (x1, x2).
3.2 Assumptions about Preferences
Transitive. If (x1, x2) ⪰ (y1, y2) and (y1, y2) ⪰ (z1,
z2), then we assume that (x1, x2) ⪰ (z1, z2).
In other words, if the consumer thinks that X is at
least as good as Y and that Y is at least as good as Z,
then the consumer thinks that X is at least as good as
Z.
3.3 Indifference Curves
We describe preferences graphically by using a
construction known as indifference curves.
Let us pick a certain consumption bundle (x1, x2)
and shade in all of the consumption bundles that are
weakly preferred to (x1, x2)
This is called the weakly preferred set
3.3 Indifference Curves
3.3 Indifference Curves
The bundles on the boundary of this set—the
bundles for which the consumer is just indifferent to
(x1, x2)—form the indifference curve.
An important principle about the indifference curve:
Indifference curves representing distinct levels of
preference cannot cross.
3.3 Indifference Curves
3.4 Examples of Preferences
Perfect Substitutes
Two goods are perfect substitutes if the consumer is
willing to substitute one good for the other at a
constant rate.
The simplest case of perfect substitutes occurs when
the consumer is willing to substitute the goods on a
one-to-one basis.
3.4 Examples of Preferences
Perfect Substitutes
Pick a consumption bundle, say (10, 10).
Then for this consumer, any other consumption
bundle that has 20 pencils in it is just as good as (10,
10).
Mathematically speaking, any consumption bundle
(x1, x2) such that x1 + x2 = 20 will be on this
consumer’s indifference curve through (10, 10).
The important fact about perfect substitutes is that the
indifference curves have a constant slope.
3.4 Examples of Preferences
3.4 Examples of Preferences
Perfect Complements
Perfect complements are goods that are always
consumed together in fixed proportions.
In some sense the goods “complement” each other.
Example: Right shoe and left shoe
Suppose consumption bundle (10,10)
We add one right shoe (11,10) – consumer remains
indifferent
3.4 Examples of Preferences
3.4 Examples of Preferences
Bads
A bad is a commodity that the consumer doesn’t like.
Neutrals
A good is a neutral good if the consumer doesn’t care
about it one way or the other.
3.4 Examples of Preferences
3.4 Examples of Preferences
3.4 Examples of Preferences
Satiation
There is some overall best bundle for the consumer,
and the “closer” he is to that best bundle, the better off
he is in terms of his own preferences.
Suppose that the consumer has some most preferred
bundle of goods (x ,x ), and the farther away he is
1 2
from that bundle, the worse off he is.
In this case we say that (x ,x ) is a satiation point, or
1 2
a bliss point.
3.4 Examples of Preferences
3.4 Examples of Preferences
The indifference curves have a negative slope when
the consumer has “too little” or “too much” of both
goods, and a positive slope when he has “too much”
of one of the goods.
When he has too much of one of the goods, it becomes
a bad
Discrete Goods
Discrete good is a good that is only available in integer
amounts
3.4 Examples of Preferences
3.5 Well-Behaved Preferences
Defining features for well-behaved indifference
curves:
First we assume more goods are better
If (x1, x2) is a bundle of goods and (y1, y2) is a bundle of
goods with at least as much of both goods and more of
one, then (y1, y2)≻(x1, x2).
This assumption is sometimes called monotonicity of
preferences.
3.5 Well-Behaved Preferences
3.5 Well-Behaved Preferences
Second, we are going to assume that averages are
preferred to extremes.
That is, if we take two bundles of goods (x1, x2) and (y1,
y2) on the same indifference curve and take a weighted
average of the two bundles such as
(1/2x1+ 1/2y1, 1/2x2+ 1/2y2)
then the average bundle will be at least as good as or
strictly preferred to each of the two extreme bundles.
3.5 Well-Behaved Preferences
Actually, we’re going to assume this for any weight t
between 0 and 1, not just 1/2. Thus we are assuming
that if (x1, x2) ∼ (y1, y2), then
(tx1 + (1 − t)y1, tx2 + (1 − t)y2) ⪰ (x1, x2)
for any t such that 0 ≤ t ≤ 1
3.5 Well-Behaved Preferences
Geometrically it means that the set of bundles weakly preferred to
(x1, x2) is a convex set.
Suppose that (y1, y2) and (x1, x2) are indifferent bundles.
Then, if averages are preferred to extremes, all of the weighted
averages of (x1, x2) and (y1, y2) are weakly preferred to (x1, x2) and
(y1, y2).
A convex set has the property that if you take any two points in the
set and draw the line segment connecting those two points, that line
segment lies entirely in the set.
3.5 Well-Behaved Preferences
3.5 Well-Behaved Preferences
One extension of the assumption of convexity is the
assumption of strict convexity.
This means that the weighted average of two
indifferent bundles is strictly preferred to the two
extreme bundles.
3.6 The Marginal Rate of Substitution
The slope of an indifference curve is known as the
marginal rate of substitution (MRS).
The name comes from the fact that the MRS
measures the rate at which the consumer is just
willing to substitute one good for the other.
3.6 The Marginal Rate of Substitution
3.6 The Marginal Rate of Substitution
3.7 Other Interpretation of the MRS
The MRS measures the rate at which the consumer is
just on the margin of being willing to substitute good 1
for good 2.
We could also say that the consumer is just on the
margin of being willing to “pay” some of good 1 in
order to buy some more of good 2.
So sometimes we can say the slope of the indifference
curve measures the marginal willingness to pay.
3.8 Behavior of the MRS
It is sometimes useful to describe the shapes of
indifference curves by describing the behavior of the
marginal rate of substitution.
For Example:
Perfect substitutes: MRS = -1
Neutrals: MRS is everywhere infinite
Perfect Complements: MRS is zero or infinity
3.8 Behavior of the MRS
The assumption of monotonicity implies that indifference curves
must have a negative slope
The case of convex indifference curves exhibits yet another kind of
behavior for the MRS.
For strictly convex indifference curves, the MRS—the slope of the
indifference curve—decreases (in absolute value) as we increase x1.
Thus the indifference curves exhibit a diminishing marginal rate of
substitution.
