Transcript Intermediate Microeconomics
Intermediate Microeconomics
Preferences 1
Consumer Behavior
Budget Set organizes information about possible choices available to a given consumer. Next step is to determine how a consumer will choose among the bundles available in his or her budget set.
To do so, we make the seemingly obvious assumption that individuals are
rational:
Each individual chooses the bundle he or she
most prefers
among all bundles available in his or her budget set. Therefore, we first need to develop a theory of
preferences
, that is both flexible and yet restrictive enough to be useful for understanding how choices will change as the economic environment changes.
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Theory of Preferences
Consider again a
bundle
of goods denoted
A
-{q 1 A , q 2 A , …, q n A } For any given individual and any given bundle
A
, we want to be able to describe the following sets: Strictly preferred set – all bundles the individual
strictly
prefers to
A
.
Weakly preferred set – all bundles the individual
weakly
prefers to
A
(i.e. likes
at least as much as A
) Any bundle not in weakly preferred set, the individual must like strictly
less
than A.
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Preferences
3 axioms in our theory of consumer preferences 1.
Completeness
– An individual can
weakly
rank any two possible bundles.
2.
Reflexivity
– A bundle is at least as good as itself.
3.
Transitivity
– If a bundle C is strictly preferred to a bundle A, and an individual is indifferent between a bundle A and another bundle D, then the individual must also strictly prefer bundle C to bundle D.
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Preferences
Final common assumption - preferences exhibit “non-satiation” or monotonicity.
Weaker version: “more can’t be worse.” Essentially assumes free-disposal Stronger version: “more is always better” Certainly not true at levels (100 donuts does me no better than 99) For practical purposes though, not bad, as we want to model situations where individuals have to make choices between things they value.
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Preferences
Key issue we want to understand and analyze in economics is trade-offs.
e.g. how much of one good is an individual
willing
to trade-off to consume more of another good?
Our preference axioms allow us to consider such trade-offs via
indifference curves.
For any given bundle A, there is an
indifference curve
that connects A to each bundle B where a given consumer is indifferent between A and B. 6
Indifference Curves
Characteristics of Indifference Curves Consider one of your indifference curves between number of chips and ounces of Coke.
Is every possible bundle on an indifference curve? Why or why not? How many indifference curves are there?
If A is on a higher indifference curve than B, what does this mean? How do we know this?
Why are indifference curves drawn with a negative slope?
Can indifference curves cross? Why or why not?
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Interpreting Indifference Curves
q 2 Δq 1 q 2 ’ Δq 2 q 1 ’ q 1 Indifference curve indicates that at bundle {q 1 ’,q 2 ’}, an individual will be willing to give up Δq 2 units of good 2 to increase consumption of good 1 by Δq 1 .
What happens as Δq 1 goes to zero?
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Interpreting Indifference Curves
Marginal Rate of Substitution (MRS)
– the slope of indifference curve at a given point.
MRS indicates an individual’s
willingness to-pay
for a marginal increase of one good in terms of the other,
at a given bundle
.
So how do you interpret an indifference curve when it is very steep at a given bundle (i.e. slope large in magnitude)?
How about when it is relatively flat?
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Well-behaved preferences
In addition to our three Axioms and monotonicity, we will also generally assume that weakly preferred sets are
convex
.
Convex preferences
– If bundles B-{q 1 B , q 2 B } and C-{q 1 C , q 2 C } are in weakly preferred set to A, then so will the bundle {(q 1 B + q 1 C )/2 , (q 2 B + q 2 C )/2 }.
For example, consider the bundle {2,2}. Suppose that for some person, both {1,3} and {4,1} are in the weakly preferred set to {2,2}.
Then, if this person’s preferences are convex, the bundle {2.5, 2} will also be in the weakly preferred set.
Intuition: averages are at least as good as extremes, or that individuals prefer to have a combination of goods at moderate levels to lots of one and little of the other (consider chips and coke) Monotonic and Convex preferences are called
well-behaved
preferences.
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Interpreting Indifference Curves
Consider an indifference curve of following form. q 2 Does it represent convex preferences?
q 1 What does this shape reveal about MRS as q 1 increases and q 2 decreases?
What is intuition?
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Interpreting Indifference Curves
Diminishing MRS
Implies an individual’s willingness to trade one good for another diminishes the less he has of that good. Slope of Indifference Curve “decreases” as q 1 increases and q 2 falls.
What is intuition?
Examples: Chips and Coke?
Coke and a composite good?
Coke and Pepsi?
What is intuition behind different shapes of indifference curves?
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Interpreting Indifference Curves
Perfect substitutes
- constant MRS Examples? What will indifference curves look like?
Perfect Complements
– must consume in fixed proportions, or individual not willing to trade off some of one for more of another, therefore MRS is undefined.
Examples?
What will indifference curves look like?
Are such preferences well-behaved?
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q 2
Interpreting Indifference Curves
Consider the following indifference curves.
Are they well-behaved? Do they violate any of our axioms?
q 2 q 2 q 1 q 1 q 1 14
Thinking again about assumptions over preferences
While our underlying preference axioms and assumptions seem relatively innocuous, they do rule out some potentially interesting issues: Interaction between monetary value and preferences.
Peer effects 15
Modeling Preferences over Other Types of Goods
Suppose again you work for
Doctors Without Borders
What will your indifference curves look like between “treating Tuberculosis patients” vs. “treating malaria patients”?
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