Consumer preferences

– For example, a parent may have preferences over various bundles of food and clothing bought by the parent but consumed by a child
Assumptions about Preference Orderings
W2
W is worse than A. Z is better than A. So, on the line joining W and Z, there must exist a goods bundle such as B that the consumer considers equally good as A. By using this logic repeatedly, we can find many other bundles—such as B, C, and D—that are equally good as A.
– People like variety. So most indifference curves get flatter as we move from top left to bottom right – Link between slope and MRS implies that MRS declines; the amount of Y required to compensate for a given change in X decreases as X increases
Impossible Indifference Curves
B , Burritos per semester
• Lisa is indifferent between e and a, and also between e and b…
– so by transitivity she should also be indifferent between a and b… – but this is impossible, since b must be preferred to a given it has more of both goods.
• Completeness: the consumer is able to rank all possible bundles of goods and services.
– For any two bundles A and B, the consumer knows whether A is better, or B is better, or they are equally good
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Figure 4.9: Marginal Rate of Substitution
• Slope = B/S = 3/(-2) = -3/2 • MRSSB= -B/S=-3/(-2) = 3/2 • The slope—and its negative, the MRS—at bundle A can be approximated by the slope of the line AD, or the line AE, or the line AF, etc. • But the precise value is obtained from the slope of the line that is tangent to the indifference curve at bundle A.
Origin
Part of an Indifference Map
Origin
Properties of Indifference Maps
1. Bundles on indifference curves farther from the origin are preferred to those on indifference curves closer to the origin. 2. There is an indifference curve through every possible bundle. 3. Indifference curves cannot cross. 4. Indifference curves slope downward.
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What Determines Rates of Substitution?
• Tastes
– Preferences for one good over another affect the slope of an indifference curve and MRS
• Starting point on the indifference curve; the initial goods bundle
• Transitivity: for any three bundles A, B, and C, if A is at least as good as B and B is at least as good as C, then A is at least as good as C. • These two assumptions imply the ranking principle
MRSXY Y X MRSXY slopeof indifferen ce curve
• Tells us how much Y a consumer needs to compensate for losing a little bit of X, per unit of X • Tells us the maximum amount of Y a consumer would be willing to pay per additional unit of X • That is, MRSXY is the consumer’s willingness to pay Y for a unit al Rate of Substitution
• The marginal rate of substitution for X with Y, MRSXY, is the rate at which a consumer must adjust Y to maintain the same level of well-being when X changes by a tiny amount, from a given starting point
The Ranking Principle
• A consumer can rank, in order of preference, all potentially available alternatives
Assumption: More-Is-Better
• Other things equal, more of a good is preferred to less.
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Figure 4.8: Rates of Substitution
• Look at the move from bundle A to C • Consumer loses 1 soup (S = -1); gains 2 bread (B = +2) • A and C are equally desirable • Slope of indifference curve = B/S = -2 • Consumer is willing to substitute for soup with bread at 2 ounces per pint
e b a I1
0 I
Z , Pizzas per semester
Impossible Indifference Curves
B , Burritos per semester
• Lisa is indifferent between b and a since both points are in the same indifference curve…
• One gets bored with X as consumption of X increases. Therefore, one needs less Y to compensate for a unit loss of X
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Rates of Substitution
• Consider moving along an indifference curve, from one bundle to another • This is the same as taking away units of one good and compensating the consumer for the loss by adding units of another good • Slope of the indifference curve shows how much of the second good is needed to make up for a loss of the first good
– We ignore goods that are harmful or poisonous, for which more is not better than less. Such goods are jokingly referred to as ‘bads’
Indifference
Z2 D
Impossible Indifference Curves
Substitution Between Goods
• Economic decisions involve trade-offs • Indifference curves provide information on the amount of one good that the consumer is willing to give up to gain a unit of another good
– But this contradicts the “more is better” assumption. Can you tell why? – Yes, b has more of both and hence it should be preferred over a.
b
a I
Z , Pizzas per semester
Indeed, for any consumption bundle, it is possible to find other bundles that are equally good
Origin
An Indifference Curve
An indifference curve is a set of consumption bundles that the consumer prefers equally K is inferior and L is superior to the bundles on the indifference curve
Consumers’ preferences
ECO61 Udayan Roy Fall 2008
Goods bundles
Origin
Preferences
• Consumers have preferences that they can use to compare different goods bundles • The preferences may be over goods bundles consumed by oneself or over goods bundles consumed by someone else